Picking Pockets at the Pump

Picking Pockets at the Pump

February 2, 2002

Eager to pay more at the pump? If so, some Virginia politicians want to help you out. A bill introduced by Sen. Charles Hawkins (R-Chatham), and recently approved by the Senate Commerce and Labor Committee, would severely limit the ability of gasoline retailers to cut prices. If enacted, Virginians will pay more for each gallon of gasoline they buy – and a total of $58 million more each year to fill up.

The alleged justification for this bill is that some gasoline retailers – most notably, Sheetz and Wawa – charge prices that are too low (!). These low prices supposedly will bankrupt independent retailers, leaving Sheetz and Wawa with the power to raise gasoline prices to extortionate levels.

The bill’s supporters argue that to save consumers from high prices tomorrow, we must protect them from low prices today.

This story – economists call it “predatory pricing” – is not completely implausible. It is imaginable that today’s low prices could bankrupt existing competitors and frighten away potential entrants so that the price cutter becomes a monopolist. But almost anything is imaginable. For example, it’s imaginable that a meteorite will crash through my roof. But I won’t waste time reinforcing my roof against meteorites, even though a small chance exists that one will land there.

Decades of economic research show that fretting about predatory pricing is about as sensible as fretting about crashing meteorites.

Consider why predatory pricing is a highly unlikely means of monopolizing markets.

Suppose Sheetz really does aim to monopolize gasoline retailing with predatory pricing. The first effect Sheetz feels is losses much larger than those of its rivals. After all, while rivals might have to meet Sheetz’s below-cost prices, at least they can reduce the number of below-cost sales that they make (say, by reducing their hours of operation). In this way they keep their losses to a minimum. Sheetz enjoys no such luxury, for during the price war it must expand its unprofitable sales if it is to snatch rivals’ customers. If Sheetz merely lowered its prices without increasing sales, it would not take customers away from rivals. Rivals would not have to lower their prices.

All economists agree that a predatory-pricer suffers far larger losses than the loses that he inflicts upon his rivals.

This fact alone makes claims of predatory pricing suspect. But suppose, for argument’s sake, that Sheetz can endure losses better than its rivals. Sheetz is still far from succeeding at its goal of monopolizing the market. The reason is that new entrants will take their place should existing competitors go out of business. This entry denies Sheetz the monopoly power that it paid so dearly to pursue.

Don’t think that such entry is unlikely. America has many very capable oil companies willing to quickly enter any market promising profits. It’s unthinkable that ExxonMobile and other big refiners would not leap more fully into Virginia’s retail-gasoline market if they saw the likes of Sheetz charging monopoly prices. Sheetz might intimidate a local mom-and-pop, but executives at Texaco or Sunoco would be eager to take on Sheetz if it is putting the screws to Virginia motorists.

Predatory pricing is so unlikely to work that no firm will practice it. Sheetz’s low prices really reflect Sheetz’s greater efficiency at serving consumers.

Economists have looked hard for real-world examples of predatory pricing. Like meteorites crashing into suburbia, they are rarely found. Professor William Baumol – one of the profession’s most respected scholars – surveyed the record and concludes that “genuine cases of predation are very rare birds.”

But, you might ask, what’s the harm of legislation aimed at stopping predatory pricing when it does happen? The answer is that such legislation is too easily used to stifle competition – the exact opposite effect that its supporters claim to want.

Experience shows that when firms can use antitrust law to accuse their entrepreneurial rivals of competing too vigorously, many firms take advantage of this opportunity to compete in the courtroom rather than in the marketplace. The perverse effect is that legislation seemingly meant to enhance competition ends up strangling it.

This effect certainly holds true in those ten states that have passed statutes similar to the one now being considered in Virginia. Research shows that these statutes raise the retail price of gasoline by more than 1.6 cents per gallon.

Virginians buy about 3.6 billion gallons of gasoline annually. Consequently, passing this bill will tax Virginians an extra $58 million each year. That’s too high a price to pay for protection from a phantom threat.