Today the Competition Bureau - Canada's watchdog agency for things involving market structure and competition - announced that it has begun an investigation into allegations of price-fixing among chocolate bar makers in Canada. You can read about the story at CTV's website. While the story itself is rather interesting, what prompted me to write this blog entry are some of the talk-back comments on the CTV website.
A number of people continue to insist that price fixing is going on in gasoline retailing and that the Bureau should be investigating the gasoline retailers instead of wasting their time on something as trivial as chocolate bars. The fact is that the Bureau has had a number of investigations in the past into gasoline pricing and not found evidence of price fixing. Maybe they didn't look hard enough. Or maybe, just maybe, the people that insist that there is price fixing in gasoline are misunderstanding the symptoms.
What gets people all worked up about gasoline prices and convinces them that prices are fixed is that gasoline prices always move in unison among nearby dealers. Well, that's exactly what one would expect to happen in a competitive market! You have to remember that gasoline is pretty much a homogeneous good -- perfectly substitutable across brands. My car runs just fine on regular unleaded regardless of where I buy it. Thus, each gasoline retailer's product is a perfect substitute for their competitors' products. This perfect substitutability means that prices have to move in locked-step.
Suppose that you are driving down the road and need to buy gas. On one corner you see the price is $1.10 and on an equally accessible location the price is $1.08. Where are you going to buy fuel? If you are like most consumers and concerned about price, you will buy it where it is cheapest. The retailer trying to charge $1.10 will lose all of his/her sales. In order to prevent that they must match their competitors' prices. Before you know it, everyone is charging $1.08. Hardly evidence of price fixing.
This is distinctly different from the case of goods that are not perfect substitutes. Suppose that you are in the market for a new car. You could buy a new Ford Focus for about $20,000 or you could buy a new Kia Rio for about $14,000. Why is Ford able to charge $20,000 for the Focus when the Kia is so much cheaper? Because the goods are not perfect substitutes (at least in the eyes of consumers).
In the case of chocolate bars, what is particularly interesting is that the goods are not perfect substitutes - an Oh Henry bar is not the same as a Mr. Big or a Jersey Milk - they are very different products. However, it is interesting that they are all priced the same. Now, the fact that heterogeneous, competing goods are priced the same is not in itself evidence of price fixing. There may be very sound business reasons for standard pricing such as price list simplicity. The point that I am trying to make here is that how close the prices are among competing products or services depends largely on how substitutable the goods are.
As the degree of substitutability between competing products increases, there is less and less room for dispersion. In the case of gasoline prices, the products are very nearly perfect substitutes. As a result we would expect prices to exactly match across competing retailers. Just because prices move together does not mean that prices are fixed, it may actually be a sign of fierce competition.
A number of people continue to insist that price fixing is going on in gasoline retailing and that the Bureau should be investigating the gasoline retailers instead of wasting their time on something as trivial as chocolate bars. The fact is that the Bureau has had a number of investigations in the past into gasoline pricing and not found evidence of price fixing. Maybe they didn't look hard enough. Or maybe, just maybe, the people that insist that there is price fixing in gasoline are misunderstanding the symptoms.
What gets people all worked up about gasoline prices and convinces them that prices are fixed is that gasoline prices always move in unison among nearby dealers. Well, that's exactly what one would expect to happen in a competitive market! You have to remember that gasoline is pretty much a homogeneous good -- perfectly substitutable across brands. My car runs just fine on regular unleaded regardless of where I buy it. Thus, each gasoline retailer's product is a perfect substitute for their competitors' products. This perfect substitutability means that prices have to move in locked-step.
Suppose that you are driving down the road and need to buy gas. On one corner you see the price is $1.10 and on an equally accessible location the price is $1.08. Where are you going to buy fuel? If you are like most consumers and concerned about price, you will buy it where it is cheapest. The retailer trying to charge $1.10 will lose all of his/her sales. In order to prevent that they must match their competitors' prices. Before you know it, everyone is charging $1.08. Hardly evidence of price fixing.
This is distinctly different from the case of goods that are not perfect substitutes. Suppose that you are in the market for a new car. You could buy a new Ford Focus for about $20,000 or you could buy a new Kia Rio for about $14,000. Why is Ford able to charge $20,000 for the Focus when the Kia is so much cheaper? Because the goods are not perfect substitutes (at least in the eyes of consumers).
In the case of chocolate bars, what is particularly interesting is that the goods are not perfect substitutes - an Oh Henry bar is not the same as a Mr. Big or a Jersey Milk - they are very different products. However, it is interesting that they are all priced the same. Now, the fact that heterogeneous, competing goods are priced the same is not in itself evidence of price fixing. There may be very sound business reasons for standard pricing such as price list simplicity. The point that I am trying to make here is that how close the prices are among competing products or services depends largely on how substitutable the goods are.
As the degree of substitutability between competing products increases, there is less and less room for dispersion. In the case of gasoline prices, the products are very nearly perfect substitutes. As a result we would expect prices to exactly match across competing retailers. Just because prices move together does not mean that prices are fixed, it may actually be a sign of fierce competition.
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