Asymmetries in Retail Gasoline Price Dynamics and Local Market Power

Abstract

Using monthly data from the 48 contiguous states (except Nevada) for the 1988-2002 period, it is shown that retail gasoline prices respond faster to wholesale price increases than to equivalent wholesale price decreases. Moreover, markets with high average retail-wholesale margins experience a slower adjustment and a higher degree of asymmetry. These results are robust to whether or not an error correction term is used, and to a number of other specifications. Since gasoline is the only variable input, one could reasonably assume that average margins in a state reflect the degree of market power at the retail level. This suggests that sticky prices and response asymmetries in the gasoline market are, at least partially, a consequence of retail market power, raising the possibility that slow price adjustments and asymmetric price responses could be used as an indicator of potential departure from perfect competition. It is also shown that out-of-sample forecasts based on asymmetric models yield substantially better predictions for the path of retail prices than forecasts based on the symmetric models. This result is robust to different measures of forecast accuracy. The higher accuracy of the out-of-sample forecasts based on asymmetric models indicates that these asymmetries are not just an outcome of fitting to a particular sample but represent the underlying data generating process.