Collusion, retail petrol prices, and market activism
Posted June 4, 2008on:
In New Zealand there has been an email going around suggesting that everyone should stop purchasing petrol from selected retailers (such as BP) in order to start a price war.
Now I accept that this doesn’t make much sense in the face of no collusion – which currently appears to be what is going on (h.t. No PC). However, if we did have collusion, how would this scheme work?
For collusion to work we need some way for the greater industry profits to be shared among the market participants. A common assumption in economics is that we have firms selling homogeneous products (which seems fair for looking at retail petrol) and as a result if all firms set the same price they will share the profit equally. In this case, given the firms rate of time preference, they may be able to sustain a collusive agreement.
Now the emailers strategy works in the following way. He hopes that as long as the retail petrol price is above a certain “fair rate” he will be able to organise people so that they consume in the following way. Firstly, they look at the price – any infinitesimal difference in price between retailers will lead to all the consumers shifting to buy off them. Secondly, if prices are all the same then they randomly shop at any petrol station – expect one (say BP).
In this case, a collusive equilibrium is not possible above the “fair price”. The reason for this is that if everyone set the same price, BP would want to defect and cut prices (as they are getting no clients). Furthermore, if BP cuts prices the others can’t continue to collude – as all the customers have moved to BP. As a result, they will want to cut prices in order to get customers back. Given this, the consumer activism in this case will lead to prices falling to their “fair rate”.
Now this was a gross oversimplification, factors such as distance, brand loyalty (schemes) and service will also influence peoples shopping decisions. However, with petrol being such a homogeneous good, there is a definite possibility that “market activism” such as this could effectively change the outcome in the industry.
Furthermore, there is nothing wrong with such activism. In this case consumers are using their market power to extract surplus in the face of an oligopoly that is using its market power to extract surplus – sound fair to me 🙂