Lags in the response of gasoline prices to changes in crude oil prices: The role of short-term and long-term shocks

Abstract

Using weekly data for the period March 1991 to August 2002, we estimate the response of retail gasoline prices to changes in crude oil and spot gasoline prices in the US allowing for a possibility of two types of cost shocks to the gasoline market: long-term and short-term shocks. Our conclusion is that theoretical models should be developed that allow more than one type of input price changes and the different effect of input price changes on output prices. The empirical results support the conjecture of two types of cost shocks. As such, we find that lags in the response of retail gasoline prices to changes in crude oil prices may be due to the fact that approximately 97% of changes in crude oil prices are viewed as short-term by the market participants. When two types of shocks are considered, there is large difference between the cumulative response function of gasoline prices to long-term and short-term shocks to crude oil prices. As such, this paper adds to our understanding of the price stickiness of gasoline prices.