Estimating Demand with Consumer Heterogeneity: an Application to Wholesale Price Regulation in Retail Gasoline Markets

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The purpose of this research program is two-fold. The first purpose is to contribute to the current literature on the specification of consumer preferences in discrete choice models of consumer demand. The research program develops a random coefficients discrete choice model of demand for retail gasoline that allows for heterogeneous consumer types with correlated preferences across product characteristics. This flexibility will allow for preference patterns such as brand-loyalty in the demand estimation - a preference pattern that is incompatible with an assumption of independently and identically distributed idiosyncratic consumer preferences. This research program will then use discrete changes in the brand identities of retail stations in Southern California to test which modeling assumptions are able to more accurately predict actual changes in equilibrium prices resulting from exogenous changes to brand identities. The second purpose of this study is to provide a framework for analyzing the potential impacts of wholesale price regulation and competition in the gasoline industry. Policy makers at the state and federal levels have proposed wholesale price regulation as a means to restore 'competitive' retail price patterns in retail gasoline markets. Fair Wholesale Price legislation (FWP) would prevent wholesale gasoline suppliers from price discriminating between retail stations. Instead of charging different wholesale prices to different stations, as is currently the practice, refiners would be required to charge the same price to all retailers. This research project will use the results from the discrete choice demand estimation developed above to simulate the impact of FWP legislation. This simulation exercise will be used to answer the following pressing policy-relevant questions: Would average retail prices increase or decrease as a result of FWP? What market factors influence the direction and magnitude of the estimated effect? Is FWP a regressive or progressive policy - will it lead to higher or lower prices in disadvantaged socioeconomic communities? Is there an alternative policy might increase competition in retail gasoline markets, leading to lower prices and decreased price dispersion? This detailed and rigorous empirical estimation of the effects of FWP legislation will guide policy makers at the state and federal level as they consider legislation aimed at increasing competition in retail gasoline markets.