Determinants of Gasoline Prices: Analyzing Consumer Behavior, Market Competition, and Tax Incidence

This paper develops a theoretical model where gasoline is an input in the production of income since it must be used to commute to work. Individuals must balance the additional income that can be obtained by traveling further from their homes to work, against the cost of the additional expenditure on gasoline which reduces the available income for consumption on other goods. The demand for gasoline is therefore a derived demand depending upon the optimal time to commute to work. On the supply side, gasoline stations operate in a monopolistic competitive market since they differ in proximity to the consumers’ homes. Therefore, this model highlights the factors that should be included in empirical estimations of the price of gasoline.Using detailed daily data on gasoline prices from New Jersey for a year which included a substantial tax increase, we analyze the effects of demand and supply factors such as travel time to work, labor force participation and means of transportation to work along with the wholesale costs, tax rates, gasoline brands and station density on retail gasoline prices for regular and premium fuel. Our findings reveal significant pass-through of taxes to consumers, with a greater than one for regular gasoline compared to premium. Market competition, captured through the density of gasoline stations, consistently lowers prices for both regular and premium gasoline. Spatial and income effects further highlight how commuting behavior influences price dispersion. The longer that individuals must commute to work the lower the gasoline prices near their homes. We also explore how the relative prices of regular and premium gasoline behave following tax increases. Finally, we present results that a large tax increase as was the case for NJ can result in structural breaks in the determinants of gas prices. The results underscore the dynamic interactions between consumer preferences, market structures, and tax policy in shaping gasoline prices.