Monday, August 29, 2005

Price Fixing, Hawaii style

Hawaii is implimenting price-caps on wholesale gasoline prices, tied to the prices in three markets on the mainland.
The Honolulu Star-Bulletin Reports the govenor opposes price-caps, and instead wants refineries to publically list their costs, arguing this information, if it shows high profits, will encourage others to enter the market.

If the Hawaiian market is competitive, economists would predict that the price cap would reduce the supply of gasoline, and retail prices would rise rather than fall.

However, if the Hawaiian market is not competitive (there are only two refineries), then a price cap would not reduce output, but could actually encourage more production and prices at the retail level would fall. This would occur, because as prices drop there will be a greater demand for gasoline, which the refineries would be willing to fulfill.

There is also a third option: the market is not competitive, but each company sees it in its own best interest and the interest of the industry to demonstrate that price caps are a bad idea, even in a duopoly market in Hawaii. In this senereo, market forces after implimenting the price-cap would encourage higher production and lower prices, but companies would seek a longer term profit by ensuring the price-cap failed. They can do this simply by reducing production for a couple of months. And, if each of the refiners is operating near full capacity, they would not have to worry that the other refiniery would make up for their own reduced output.

An agreement between each of the companies to reduce supply would be illegal, but it is not illegal for each to strategically reduce supply, knowing that the other refiner should do the same thing.

For a less analysis see here

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