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Apr
17
Is ignorance good?
April 17, 2008 | 12 Comments | Joshua Gans
According to Opposition Leader, Brendan Nelson, apparently so. He is against government moves to make the prices of petrol stations more observable to consumers on the grounds that it will reduce the perceived discount that those who currently engage in a costly search for bargains are able to get.
So let’s try and understand what is going on. Petrol prices in Eastern capital cities have a weekly price cycle whereby on Tuesdays and Wednesdays prices are lower than on other days. This is surprising behaviour in a competitive market.
To explain this: suppose that there are two consumer types — hunters and fillers. Fillers don’t know or have the time to search for the best petrol deals. They fill up when they need to. On the other hand, hunters are shrewd individuals who what to pay less for petrol. If necessary, they will search around — in their cars — for the lowest price. But if they learnt that prices were lower on a particular day, they would convert their searching energy into queuing and planning energy and fill up on that day.
Now add competitive petrol stations into the mix. Why follow a weekly price cycle? Well, suppose one of them did not and decided to discount on Friday rather than Tuesday. In this situation, they would be giving a gift to fillers but not be attracting too many more of them and so they would not make up their revenue on volume there. What about the hunters? Well, they would have to match the Tuesday price but also change the hunter’s knowledge. For a hunter, they could fill up on Friday but then again, on Tuesday they know that more than one station is competing for them. When petrol prices are intrinsically volatile, it is a better bet to stick with Tuesday. So there is no uptake in volume from hunters either — indeed, a petrol station may not have wanted that anyway. It is fillers that bring in the real bucks.
Now suppose that, for some reason, there was a big increase in the proportion of hunters — say, because petrol prices are now on the Internet and it is easier for all hunters to search for the best deal. In this situation, an individual petrol station could discount on a different day and attract more buyers. Basically, once the share of hunters gets high enough, a tipping point can occur and the clear bargaining days will become fewer but on the flip-side, petrol most of the time will be cheaper.
So what Brendan Nelson is saying is this: don’t provide this information because it will make more people savvy and that will harm those who are currently benefiting from the ignorance of others. That neither seems fair nor efficient. What next? Don’t ensure savers are getting good financial advice because more financially literate savers would not be able to get their perceived discounts? Come on. Information is a good thing and to the extent that it makes markets more competitive, even better.
Comments
12 Responses to “Is ignorance good?”
Oh, come on, now you are being ridiculous.
Nelson said nothing of the sort.
The point is that the private sector already publishes this information eg Motormouth.
Why is the taxpayer being forced to pay for something that the private sector already provides for free?
Motormouth does not provide data on every petrol station in an area.
If Nelson did not say this what did he mean when he said that bargain hunters will be worse off.
Could you also say something about how it will work for those who aren’t fillers? That is, most of the discussion I’ve seen of the scheme presumes people always fill their car, but some ( a lot? most? half?) don’t fill up. Presumably FuelWatch is helpful to those who put in $20 or $30 or $10 at a time?
Tim, I don’t know about proportions on that front but it is a good question.
I used the term fillers as a substitute for naive or less savvy. I can imagine partial fillers can be either savvy or not and would just fall into either camp. So this policy will have a similar impact on them.
Hi Joshua,
I appreciate the point you are making – though I am less convinced there is a lot of search going on because of data I’ve seen – but am happy to think of the stations engaging in price discrimination over time which is the same sort of story.
Providing more information reduces the ability to price discriminate reduces market power which improves efficiency, which is good.
There are two components of the reform – adding more information and locking the prices in.
The question is whether the cost of doing this exceeds the benefit from doing so. The ACCC report cautions about the administration and compliance costs of such a scheme.
Furthermore, it seems a considerable extension of what competition policy does to reduce the ability of firms to price discriminate – why stop at petrol – for example why not require car retailers to only sell Saturn-style to reduce their ability to price discriminate? Why not restrict the ability of retailers of other goods to run sales (which is the same sort of thing – a colleague has assured me that there are semi-regular but less obvious cycles in prices of groceries)
I guess it comes down to welfare losses – and given the demand for petrol is pretty inelastic in the short run, would like to see better estimates of the likely gains from the policy and estimates of the administration costs before going this extra step.
Thanks Joshua – it would be interesting to know the proportions.
And at the risk of doing an interview via a comments box (!): what do you say to the criticism that the scheme is ill-judged on the grounds that we should be making access to fossil fuels more difficult, encouraging alternative forms of transport (public), instead of making it easier for people to spend their hard-earned on petrol? That’s another argument I’ve seen a few times now.
He was referring to the 24 hour rule.
“we should be making access to fossil fuels more difficult”
No we shouldn’t. We should be expecting motorists to contribute to the cost of the externality that burning fossil fuel creates. This means putting the price up across the board, not leaving impediments in the way of motorists to obtain the best price available at the time.
If we really thought that making access to petrol more difficult was the way to go, we could require petrol stations to limit their opening hours to, say, midnight to 6am.
I think there would be universal agreement that, while that might cut fossil fuel consumption, it is a pretty stupid way of going about it.
Joshua did you do a write up of Hal Varian’s 1980 AER paper for the Fin in the late 1990s? I seem to recall that you did, but can’t find it anywhere. I don’t see that the Varian model (basically what you’ve got above) points to any market failure that government can impove on.
Sorry, the arguments I’m talking about meant “more difficult to access” in the sense of “more expensive”. The arguments I’m talking about think the scheme is bad bc it can lower the price. See here for an eg: (link)
Joshua, how did the price effects actually take place in WA? I mean, did the servos just instantly decide to reduce their prices across the board, or was it more of a demand push where people actually started responding to the new technology available and the servos changed their prices in response? ie. was it the threat of the action or the action itself that was significant?
Good idea in the short term, but it could and probably will be bad in the long term.
Government regulation that serves in some way to suppress prices inevitably creates disincentives for new competition to enter the industry.
Not only this, but reducing petrol prices will surely increase the amount of petrol usage. It’s been shown by the huge increase in public transport patronage that people can and will change their habits based on fluctuations in price. Increased petrol usage = increased harm to the environment, which was meant to be one of the Government’s priorities?
And also, lower fuel prices means less incentive to develop new innovations in terms of alternative fuel methods, as the potential markets for things like hybrid cars will diminish, if only slightly.