Department of Academics, Research and Development of the Ateneo Economics Association
A recent news article from the Inquirer dated June 3, 2008, predicted that the price of gasoline might reach Php 65 per liter. To protect the consumers from uncertain and abrupt price increases, SEAOIL Philippines, one of the growing Oil Companies in the Philippines, introduced the SEAOIL Price Lock Prepaid Gasoline Card which can be bought at Php 1,070 for 20 liters. The card ensures the consumers a fixed price of Php 53.50 per liter. In the event that the price of gasoline becomes lower than Php. 53.50, a refund will be issued by the gas company. There are certain mechanics for this offer. The card can be used for one transaction only. Once the prepaid card is availed, any unused portion will automatically be forfeited. Also, this 8 week promo can only be availed in selected gas stations.
While this news seems to offer good news for consumers, one should not forget that the basic profit-maximizing assumptions hold for firms such as this gasoline company. But it is not without a good reason that economists assume firms to always be profit-maximizing. For one reason, the best interest of the firms does not always mean the worse for the consumers, like in the example we have from the news article. Next, even though a person believes in the altruistic purpose of firms like SEAOIL, which is to provide Filipinos oil which is much more competitive in price, profit-maximizing is still logical, for it can not hope to provide help to Filipinos if it will be driven out of the market due to its losses incurred by implementation of wrong business strategies. Therefore, if the firms make such an offer, it is because it is more profitable than not making the offer.
In our opinion, SEAOIL is making use of the price discrimination. In Economics, price discrimination is a strategy being used by firms to extract more consumer surplus. In this case, which is an example of second degree (quantity-based) discrimination, firms also aim to gather information on the buyer’s preferences of certain goods. Allowing those who are willing to buy a larger quantity (20 liters) with a smaller average cost (Php. 53.50) is clearly an example of quantity-based discrimination. To further explain on this pricing strategy, we should look at how the firms deal with their expenses. A firm is most likely concentrated to selling more of their goods as long as it covers the variable cost, because most of the firms which are able to price discriminate usually have high fixed-costs such as machines, large vehicles and other capital.
SEAOIL PHILIPPINES is clearly practicing price discrimination, given these 4 assumptions:
- First, gasoline is being sold at two different prices, the normal price (Php. 58) and the lower price (Php. 53.50) when you avail of the offer.
- Second, in order for price discrimination and extraction of consumer surplus to be much more effective, the firm should be able to prevent re-selling of the lower priced gasoline. For example, a consumer might buy 20 gallons of gasoline at a price of Php. 53.50 per liter and then sell it at a much higher price say, Php. 55.00. Since Php. 55 is still much lower than the current prevailing price of Php. 58, buyers would certainly prefer it over the original price. The gasoline once placed inside the gas tank could not be re-sold thus preventing any form of secondary transactions and arbitrages, ensuring the firm greater ability to price discriminate.
- Third, through the offer, the firm is able to separate consumers according to their willingness to pay. This means that the firm is able to segment the market according to the price sensitivity – those who are willing to go for all the trouble just to get their income protected or those who are not.
- And fourth, since the market for oil is oligopoly, we recognize that it has some kind of market or monopoly power to call on such strategies. If the market for oil is perfectly competitive, it would not have any market power to price discriminate because competitive markets are price takers.
We assume that the reason why a firm calls on such strategies is because it is more profitable than not doing so. In order to explain this further, one should always bear in mind the profit-maximizing perspective. The first part of the promo’s mechanics is that the price-fixed prepaid gasoline card should only be used in a single transaction indicating instant 20 liters per transaction. This is a necessary condition for quantity price discrimination. The firm encourages the consumers to buy a considerably large amount of gasoline given the incentives of a lower price (average cost). If it happens that the buyer of the card is able to divide the 20 liters as he wishes, then the gasoline company faces the certainty of loss. There is no incentive for firms here for a consumer is able to buy at very small quantity yet at a lower price than what is profitable. Obviously, the firm would want to sell MORE quantity as long as it covers the marginal cost of producing it for it would want to distribute its fixed costs over many units.
We can also see that through the offer, the firm is able to gather information about how much the consumers are willing to buy and the average price in which demand is highest. Usually, this is done through self-selection strategies, wherein consumers are free to choose the quantity they prefer, the higher the quantity the greater the discount is given. We assume that the firm is trying to gather information on how price sensitive Filipinos are to gasoline through the number of those who will avail the offer. This might also be the reason why the offer only runs up to 8 weeks; the firm hopes to see the success of the promo in its initial period in order to decide its profitability.
As you can see, there really is more than just one side to the coin. Apart from our view, there exists the producers’ view of profitability seemingly in favor of the consumer’s welfare.
Abigail L. Ho, R. D. (2008, June 3). P65/liter gasoline price looms. Retrieved June 14, 2008, from Inquirer.net: http://newsinfo.inquirer.net/inquirerheadlines/nation/view/20080603-140361/P65liter-gasoline-price-looms
Phlips, L. (1983). The economics of price discrimination. New York: Press Syndicate of the University of Cambridge.
SEAOIL PHILIPPINES. (2008, June 10). Protect yourself from gasoline price increases. Retrieved June 14, 2008, from SEAOIL PHILIPPINES: http://www.seaoil.com.ph/news/2008_PriceLock.html