Economic expert explains why fuel prices rise fast but drop slowly
The effects of the ongoing conflicts in the Middle East bring news of have sent crude oil prices surging, then dropping just as quickly. But why aren’t those drops in crude prices reflected in corresponding drops in the price of gasoline and diesel we buy at the pump?
Economist Jadrian Wooten shared the reasons why prices shoot up so fast but float down so slowly.
As the Iran War continues, are the changes in fuel prices unusual?
“It’s a familiar story any time there’s a conflict in the Middle East: Prices shoot up fast but then take their sweet time coming back down. You could say that prices shoot up like a rocket but fall like a feather. In fact, economist Robert Bacon coined the term ‘rockets and feathers’ in the 1990s as a colorful metaphor for the phenomenon known as ‘asymmetric price transmission,”’ Wooten said.
How does this ‘rockets and feathers’ phenomenon work?
“When the cost of crude oil drops after a spike, prices won’t necessarily follow suit. It’s all about expectations. When gas station owners know their next delivery will cost more, they raise today’s price to protect the margin on tomorrow’s inventory. It doesn’t matter that the fuel sitting in the ground was bought last week at a lower price. All they care about is what it will cost them to fill the tanks back up,” Wooten said.
“It’s not just station owners feeling the squeeze. Truckers, farmers, and everyone else further down the supply chain are watching the same numbers, with a little more flexibility but the same question: how long can they absorb the higher cost before they have to pass it along?” he said.
Does the slower lowering of prices hurt businesses?
“The thing of it is, retailers may shoot prices up in anticipation of rising costs, but they have no matching incentive to rush prices back down. They’ll keep prices elevated until competition forces their hand and drivers stop pulling up to the pump to pay,” Wooten said.
“It’s not a conspiracy, though. Economists have broadly identified three forces that drive the asymmetric response, and they reinforce one another:
1. Inventory repricing. For example, a fuel station that bought fuel at a high price won’t sell it at a loss just because crude prices have dropped. It will wait for that inventory to turn over before passing savings along to customers.
2. Search costs. Rising prices frustrate drivers, spurring them to hunt for the lowest price. This initially limits how high any single station can push prices up. But once prices start falling, the competitive pressure to cut prices quickly also disappears.
3. Margin recovery. Fuel station owners squeezed during the price spike may not have been able to raise prices as quickly as their wholesale costs climbed. The decline period is a chance to quietly rebuild what they lost, but that means prices are held a little higher than strictly necessary.”
About Wooten
Jadrian Wooten, collegiate associate professor with the Virginia Tech Department of Economics, part of the Virginia Tech College of Science, is the author of “Parks and Recreation and Economics” and the Monday Morning Economist newsletter.
Media Availability
To schedule an interview with Wooten about the factors affecting oil and fuel prices, contact mediarelations@vt.edu.
