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Microeconomics Question from Walter E. Williams:Edit

Gasoline price "wars" have induced many gasoline-station owners to propose a regulatory agency to establish orderly marketing conditions in gasoline markets. Also they proposed that no service station be allowed to charge a price loss than cost, and further that no new stations be opened unless the convenience and necessity of the area warrants more stations.

  • (a) Who would benefit and who would be hurt by these proposals, if carried out?
  • (b) If the proposals were carried out, how should the commission decide who got to open a new station?
  • (c) Is it possible that a gentleman's agreement could be formed among gasoline station owners in lieu of statutes? Explain why or why not.

AnswerEdit

  • (a)These conditions would limit the competition of gasoline stations, which would lead to price that is higher than the marginal cost of providing gasoline. Owners of stations would benefit because they could make positive economic profits and consumers would be hurt because they would loose some of their consumer surplus to producers.
  • (b)The commission could hold a competitive bidding process where the individuals/firms who wanted to open a new station bid against each other. Each would rent seek up to their full amount of the projected economic profit in order to win the new license. This method would ensure that new gas stations were only open in areas that potential owners thought were the most profitable because they would bid the highest price (rent seeking) to win the approval.
  • (c)It is possible, but not likely. The gentleman’s agreement would form a cartel like condition that would suffer from the same three problems that cartels suffer from.
    • 1) incentive to cheat (because different gas stations will face different marginal costs)
    • 2) difficulty in deterring entry of competitors
    • 3) policing costs.
    • This part similar to: -WEW-063

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