SOME ASPECTS OF MONOPOLISTIC COMPETITION

IN THE

LUBBOCK, TEXAS, RETAIL GASOLINE MARKET

by

DELMAR D. HARTLEY, B.S.

A THESIS

IN

ECONOMICS

Submitted to the Graduate Faculty of Texas Technological College

in Partial Fulfillment of the Requirements for

the Degree of

MASTER OF BUSINESS ADMINISTRATION

ADDPOVSCI

August, 1958

T3

ho.2-3 TABLE OF CONTENTS

Cop. >

CHAPTER PAGE

I. INTRODUCTION 1

Purpose of Study 1

Nature of a Typical Retail Gasoline Market 2

Sampling Procedure 5

Definition of Terms 7

II. THE THEORY OF MONOPOLISTIC COMPETITION . . . . 10

The Model of Monopolistic Competition . . . 10

General Description of the Model 13

Disequilibrating Forces i 7

The Development of Excess Capacity • . 17

Hidden Price Cuts 20

III. THE LUBBOCK MARKET 21

General Description of the Lubbock Market 21

Disequilibrating Forces 29

The Development of Excess Capacity . . 30

Hidden Price Cuts 35

IV. SUMMARY AND CONCLUSIONS 39

BIBLIOGRAPHY 4 3

APPENDIX 4 4

Adequacy of the Sample 45

Summary Questionnaire--Majors 46

Summary Questionnaire--Independents 48

LIST OF CHARTS AND GRAPHS

PAGE

Long-run Equilibrium under Pure Competition 10

Long-run Equilibrium under Monopolistic Competition . . . 11

Short-run Equilibrium under Monopolistic Competition . . 14

Equilibrium with Excess Capacity 19

Cut Off Analysis of Question 3 44

Cut Off Analysis of Question 7 45

1 1 1

LIST OF TABLES

TABLE PAGE

I. Stations with Managers and Manager-Owners . 21

II. Length of Manager's Experience 22

III. Average Number of Pumps 23

IV. Price of Regular Grade Gasoline 25

V. Price of Ethyl Grade Gasoline 26

VI. Volume Change During Price War 27

VII. Stations living Premiums 35

VIII. Purposes of Premiums 36

IV

CHAPTER I

INTRODUCTION

The Purpose of the Thesis

The basic purpose of this thesis is to describe and

discuss the similarities and differences between the real-

world situation and a particular theoretical model of monopo­

listic competition. The theoretical model chosen was the

one described by Edward Chamberlin in The Theory of Monopo-

1 listic Competition. The real-world situation selected was

the Lubbock, Texas, retail gasoline market. The retail gas­

oline market.wa9 chosen because of the rather common assump­

tion that it constitutes one of the few examples of free com-

2 petition left in the economy.

It was the purpose of the survey conducted in the

Lubbock retail gasoline market to provide data to evaluate

the hypothesis that the real->world situation may be des­

cribed accurately in terms of the theoretical model of monopo-

Edward Chamberlin, The Theory of Monopolistic Com­petition, (Harvard University Press, Cambridge, Mass., 1939) Hereafter cited as Chamberlin, Monopolistic Competition.

2 Joel B, Dirlam, "The Petroleum Industry," quoted in

The Structure of American Industry^ ed. Walter Adams (The Macmillan Company, New York, 1954) p. 258. Hereafter cited as Dirlam, "The Petroleum Industry."

listic competition. The two following disequilibrating

forces, described in Chamberlin*s model were considered:

(1) the development of excess capacity, and, (2) the presence

of hidden or "under the board" price cuts within the market.

A comparison of the findings of the survey with the theo­

retical model of monopolistic competition was made to show

whether the actual market conformed with the theory in re^

spect to the two disequilibrating forces examined.

The Nature of £ Typical Retftil Gasoline Market

Because of a prevailing two price system, the retail

3 gasoline market is actually two markets in one. The two

price market is composed of two types of stations divided

by price policies into "majors" and "independents". The

majors, in pricing their products, generally maintain a

fixed price policy. The independents maintain a price

differential below the majors in order to draw attention

to their product. These circumstances have led to the two >

price system which prevails.

Majors are large firms, relatively few in number.

3 Harry £. McAllister, "The Elasticity of Demand for

Gasoline," quoted in Readings in Current Economics, eds, Morton C. Grossman, et al. (Richard D. Irwin, Inc., Homewood, Illinois, 1958) p. 200. Hereafter cited as McAllister, "Elasticity of Demand for Gasoline."

and usually of sufficient size to enable them to establish

their products in the minds of the consuming public, and

thus maintain the higher price in the two price system.

Generally a major also has enough power to establish a

price policy in the market. If a change in the price pol­

icy of one of the majors results in lowering its price, the

result will be either similar changes in the policies of

other majors or a severe loss of gallonage. An important

feature of this portion of the retail market is that the

majors face a high cross-elasticity for gasoline among

themselves. This fact partially accounts for the advent

of such things as price leadership, surplus buying programs,

and the use of secondary brands as substitutes for straight

4 price competition alone.

The lower price in the two price system is that of

the independents. Independents are usually small non-

integrated firms with relatively meager financing; therefore,

they are not in a position to keep their products in the

public's eye and must find alternative methods to attract

attention to their product. The alternative usually chosen

is a lower price. The independents as a group are selling

4 M c A l l i s t - e r , " E l a s t i c i t y of Demand f o r G a s o l i n e , "

p . 2 0 0 .

a generally homogeneous product with each member of this

group actually accounting for only a small portion of the

total market and individually facing a quite elastic demand

A high degree of cross-elasticity is present among the

independents.

Even though for an individual firm, whether major

or independent, the demand for gasoline is elastic, quite

another situation exists for the sellers as a group. The

total demand in any given market at any given time is re­

latively constant; thus, an elastic demand for the product

5 is seen by the group.

The manager of the individual firm sees the rather

elastic demand facing his firm and either overlooks or

ignores the inelastic total demand for the product; thus,

6

he is willing to cut prices at times. The immediate ob­

jective of a price cut is to increase the gallonage of the

individual station thus increasing the total revenue and

profit for the owner. Retaliation, the rapidity with

which competitors move to meet the price cut, determines

the ultimate success of the price cut. If an independent

Dirlam, "The Petroleum Industry,•* p. 254.

McAllister, "Elasticity of Demand for Gasoline, p. 200.

is the one to make the first move, he draws the Increased gal­

lonage first from other independents. As the differential

widens, some of the majors begin to feel the loss. This

could very easily be the "blunder" which precipitates a "gas

war".

It has been established in this brief introduction to

the nature of the retail gasoline market that, although total

demand is relatively constant and inelastit; the demand

faced by the individual firm in the absence of retaliation

is quite elastic. The success of any move to cut prices

and increase revenue is governed by retaliation from com­

petitors. Price cutting and retaliation could quite easily

be the cause of a gasoline price war.

Sampling Procedure

The "universe" in the sample taken for this thesis

was composed of all the outlets for the retail sale of gas­

oline located within the city limits of Lubbock, Texas.

This universe was made up of 206 outlets divided into two

groupit 138 majors and 68 independents. Thus the composition

of the universe was 67% majors and 33% independents.

7 McAllister,"Elasticity of Demand for Gasoline,"p.201.

A sample of 50 stations was chosen by means of a systei

atic selection procedure in which each fourth station was 8

chosen for study. The individual stations to be interviewed

were selected in the following manner, A street map of the

city of Lubbock was obtained from the Lubbock Chamber of

Commerce and each station located within the city limits

was recorded on the map. A number was assigned each station

beginning at the south-east corner of the city. The stations

were numbered in a pattern running from east to west the

length of the map, returning to the east and moving west­

ward on each street.

Once this part of the process was completed, four

slips of paper numbered one through four were placed in a

hat and one of the slips was drawn. The slip drawn was the

number three. The sample cases then were marked on the map

by number. Beginning with the number three each fourth

number was marked. By following this system approximately

25% of the total cases in the universe were chosen for study.

The sample thus drawn was composed of 17 independents and 33

lo Vernon T, Clover, Business Research, (Rodgers Litho,

Inc., Lubbock, Texas, 1958) p. 215. Hereafter cited as Clover, Business Research.

majors or 34% independents and 66% majors. This closely ap­

proximates the universe which was composed of 33% independents

and 67% majors. Likewise the sample was composed of each

fourth station in the universe in numerical order giving a

proportionate sample of the population. (See Appendix I,

p. 44, for the analysis of the sample for adequacy and

findings.)

Definition of Terms

Majors (major stations) may be generally distinguished

by two characteristics. They sell a widely advertised and

known product or may be affiliated with a nationally known

company, and have a price policy which prices their gasoline

above that of the "independents** (for a list of Lubbock

stations classed as majors see Appendix I, p. 45).

Independents (independent stations) generally carry

either unbranded or locally known brands and nearly always

hold their prices below those of the majors.

Pure competition is used in this thesis in the

sam e sense in which it is defined by Chamberlin in The

Theory of Monopolistic Competition. No one firm or group

of firms has any degree of control over the price of the

product. This prerequisite to pure competition may be

analyzed in two phases. "In the first place, there must

be a large number of buyers and sellers so that the influence

8

of any one or of several in combination is negligible....Second­

ly, control over price is completely eliminated only when all

producers are producing the identical good and selling it in

9 the identical market."

In monopolistic competition sellers may be selling

slightly different or very different products but "where

there is any degree of differentiation whatever, each

seller has an absolute monopoly of his own product, but is

subject to the competition of more or less imperfect sub-

10 stitutes." Each is a monopolist; yet, each is a competitor

when the product is differentiated.

Equilibrium is used in three different situations.

The first of these is the long-run equilibrium under pure

competition. This is effected when the firm's average

cost curve is, at its minimum point, tangent to the demand

curve. This will be a point of maximum profits for the

firm because it is also the point at which the marginal

cost curve intersects the marginal revenue curve. The

second use will be the short-run equilibrium under monopo­

listic competition. This is a situation of short run maximum

9 Chamberlin, Monopolistic Competition, p. 7.

10 Ibid., p. 9,

profits for the firm. At this point the firm is enjoying a

situation of greater than aormal or excess profits. The

third situation is the long-run equilibrium under monopolistic

competition. This also is a profit maximizing point of

production for the firm bu^ there is no pressure exerted

either for firms to enter or leave the field because of the

lack of excess profits and the existence of normal profits.

Disequilibrating factors are any forces which will

cause the firm*s position to vary from an equilibrium situ­

ation.

CHAPTER II

THE THEORY OF MONOPOLISTIC COMPETITION

The Model of Monopolistic Competition

The basic objective of this thesis is to compare

Chamberlin*s theoretical model of monopolistic competition

with the real-world situation of the Lubbock, Texas, retail

gasoline market. To gain this objective it is necessary

first to establish the theoretical aspects to be used. Ini-

1

• ^ \ ^

3 ^ < ?

~-~y /^C

/ ^^^^

, AD

r\

QUAf^T/TY

Figure 1, Purely Competitive long-run Eqiiilibrium

Chamberlin, Monopol ist ic Competition .

I b i d , , p . 2 1 .

10

11

tially this chapter seeks to show a skeleton model of the

theory indicating the basic change in demand caused by

monopolistic competition. Subsequently a more elaborate

description of the model will explain its operation and a

the effect of monopolistic competition on the price of the

product. Finally -the disequilibrating factors to be con­

sidered for comparison will be introduced and explained.

The model of monopolistic competition, as set up by

Chamberlin, begins with- a purely competitive firm in a

long-run equilibrium position as shown in Figure 1.

OUA/VT/TY BAM Figure 2, Long-run Equilibrium under

Monopolistic Competition"

Chamberlin, Monopolistic Competition, p. 84, The curves MM and NN have been added to Chamberlin»s Figure to emphasize the fact that this is a profit maximizing situ­ation.

12

Moving from the purely competitive situation into the

realm of less than pure competition, we find a change in he

demand curve of the firm. The demand curve becomes a line

(DD) sloping downward from left to right as appears in

Figure 2, The cause of this change in the nature of the

demand curve is some differentiation in the product which

eliminates perfect substitutability and makes the demand

less than perfectly elast^ic, This differentiation may

arise when any significant basis exists for distinguishing

the goods of one seller from those of another; be it price,

personality, reputation, convenient location, or the tone

of his shop, "Where such differentiation exists, ever

though it be slight, buyers will be paired with sellers,

not by chance and at random (as under pure competition), 4

but according to their preferences,"

While the nature of the demand curve for the firm

changes when monopolistic elements become apparent, it is

assumed that the average cost structure or curve will be

approximately the same as for a similar firm under pure

5 competition. Under this assumption then the average cost

curves in Figures 1 and 2 are the same. There is included

4 Chamberlin, Monopolistic Competition, p. 56.

5 Ibid., p. 85,

13

in this cost curve the minimum profit necessary to secure and 6

retain the services of the entrepreneur.

General Description of the Model

An explanation of the model of monopolistic competition

must necessarily begin with a basing point of the individual

firm at long-run equilibrium in a situation of pure com­

petition. Figure 1 on page 8 presents an ordinary picture

of long-run competitive equilibrium. Line D is the demand

curve; in this situation it also represents price, marginal

revenue, and average revenue. Line MC is the marginal cost

curve and line AC is the average cost curve.

In the long-run equilibrium situation the position

of each of these curves may be depicted as in Figure 1,

p, 8, The marginal cost curve intersects the marginal

revenue curve at point Q, which is the most profitable

level of output for the firm. In the purely competitive

situation this point (Q) is also the point of tangency

of the minimum level of the average cost curve and the

demand curve—the most efficient or minimum cost level of

production. This is always the situation at long-run com­

petitive equilibrium.

Chamberlin, Monopolistic Competition, p, 77.

14

QUA/S/riTV

Figure 3. Short-run Equilibrium under Monopolistic Competition

After some differentiation has been established

certain adjustments of price or of product will occur result­

ing in the maximization of profits for the individual seller.

For simplification this thesis assumes no change in product

and consequently no change in costs of production; it will

be concerned exclusively with price adjustments. The price

adjustment which will render maximum profits is shown in

Chamberlin, Monopolistic Competition, p. 89. The curves MM and NN have been added to Chamberlin's figure to emphasize that this is a profit maximizing situation.

15

Figure 3. Line DD is the demand curve and PP is the pro­

duction cost curve (this is the same as an average or unit cost

curve). MM and NN, the marginal cost and marginal revenue

curves respectively, interesect at the point of production

which will yield maximum profits for the firm. In Figure

3 quantity OA sold at price OF results in total profit FRHE.

This firm may be said to be operating at a short-run equi­

librium realizing a profit in excess of that necessary to

remain in business. In the short-run a substantial increase

in price results from the introduction of differentiation

of the product and subsequent price adjustment to maximize

profits.

Moving into the long-run period, however, further

adjustments take place. These adjustments, the result of

the excess profits being enjoyed (Fig. 3), are the entry

of new firms into the field in order that they too might

enjoy this highly profitable situation. As new firms enter

the field the consequence is a division of demand between

a larger total number of firms. The demand curve facing the

individual firm, as a result of this division of the total

market between a larger number of firms, shifts downward

and to the left. This shift results in a movement along the

cost curve of the firm to the left of the most efficient

16

point of operation. This movement or adjustment will continue

until a new long-run equilibrium has been reached. This

equilibrium position will be a situation of maximum profits.

The demand curve will be tangent to the average cost curve,

thus, yielding only the profit necessary to retain the ser­

vices of the entrepreneur; however, the result will be a

price higher than the price at long-run equilibrium under

pure competition.

In Figure 2 on page 9, DD is the demand curve from

Figure 3 on page 11 representing short-run equilibrium demand

with maximum profit at point R. As more firms enter the

field the firm's demand curve shifts to the left and the

series of adjustments culminates ultimately in dd, the

new demand curve. The new demand curve is tangent with PP

(average cost curve) at point Q. Thus, the new level of

output will be OB at price BQ. Note that this solution also

constitutes maximum profits, the new marginal revenue curve

intersecting the marginal cost curve at this level of output.

Output OB is always a smaller quantity at a higher price

than would be found under a purely competitive situation.

In Figure 2 on page 9 point k would be the point of pro­

duction under pure competition giving an output OM and a

price MK.

It has been noted that the situation depicted in

17

Figure 2 on page 9 is a long-run equilibrium situation under

mo nopolistic competition. There is no pressure in the case

of a long-run equilibrium for new firms to enter or old

firms to leave the field. Forces causing a disturbance

in this situation may now be introduced.

Some Disequilibrating For ces

The first desequilibrating force to be considered

is the development of excess capacity. Suppose that new

firms (resources) enter the field when the situation is

depicted as in Figure 2 on page 9, thereby giving rise to

excess capacity. There is a two-fold cause for entry into

8 the field under these conditions; first, as the result of

miscalculation as to the profit potentiality of a new firm;

and second, as a result of psychological factors resulting

in an effort by individuals to find a place in business for

themselves. With the entry of new firms the demand curve

for each individual firm would be pushed still further

to the left and at the resulting price costs would not be

covered. "Lower prices would only make matters worse;

business men generally would find a higher 'margin* neces­

sary in order to make both ends meet; they would therefore

8 Chamberlin, Monopolistic Competition, p. 105.

18 9

increase it and prices would again equal costs of production."

This is a case of excess capacity resulting in an increase in 10

prices. This will continue until the demand curve (Figure 4)

is tangent with the cost curve at a very high level.

There is a difference in the nature of the firm's

demand curve in Figure 4 and the demand curves pictured in

Figure 2, page 9, and Figure 3, page 11. A comparison will

readily reveal that the demand curve in Figure 4 is somewhat

less-elastic than those in Figures 2 and 3. The reason for

this change is the introduction of retaliation. Up to this

point in the exposition it has been implicitly assumed that

any change in an individual firm's prices could be effected

without retaliation. Such an assumption results in a highly

elastic demand for the individual firm when viewing this

firm as a price cutter. The introduction of retaliation will,

however, substantially modify this situation and tend to

force the individual's demand curve into the same mold as the

11 group's demand curve, a somewhat inelastic demand.

Chamberlin, Monopolistic Competition, p. 105.

10 Ibid., p. 106.

11 Kenneth E. Boulding, Economic Analysis, (Harper & Bro­

thers, New York, 1955) p. 645.

19

Q(/A/vr/ry

Figure 4. Equilibrium with excess capacity 12

An entirely different situation exists when the in­

dividual firm is raising its price. If an individual firm

alone raises the price of gasoline, with the market generally

holding prices stable, it faces a highly elastic demand curve.

This is retaliation in the sense that when one firm raises its

price the great bulk of the other firms must also raise their

prices in order to hold each firm's share of total demand

1 2

Chamberlin, Monopolistic Competition, p. 92. For purposes of simplification all lines indicating the process which culminates in DD tangent with PP at point Q have been deleted from Chamberlin's figure.

20

approximately the same. Unless this is done the price raiser

faces a situation of a high cross-elasticity of demand and

will loose the bulk of his market. It may be noted that price

increases with retaliation present result in a highly elastic

demand facing the individual firm while the reverse is true

for the price cutting firm. The actual price range through

which prices may vary as excess capacity becomes evident will

vary with the elasticity of demand but generally will approxi­

mate the range from point Q (Figure 2) to point Q (Figure 4 ) .

Another factor which must be considered as an important

disequilibrating force is the hidden price cut. It has been

indicated that in the absence of retaliation the individual

firm faces a rather elastic demand curve. With this in mind,

it follows that if an individual firm can devise some hidden

or "under the board" price cut which can avoid retaliation

it can substantially increase the quantity of gasoline it

sells. These price cuts may be any extra consideration of

13 any sort, premiums, coupons, prizes and the like. The

effect is to give the secret price cutter a somewhat secure

incr ea se in volume of sales because of the reduced possibility

of others following him, thus, holding the general level of 14

prices artificially high.

13

14

Chamberlin, Monopolistic Competition, p. 108.

Ibid., p. 108.

CHAPTER III

THE LUBBOCK MARKET

General Description of_ the Lubbock Market

The Lubbock, Texas retail gasoline market was composed

of two general types of stations, the majors and the indepen­

dents. There were 206 outlets, of which 138 (67%) were majors

and 68 (33%) were independents.

Certain contrasts may be noted between the two groups

within the Lubbock market. The independent is often considered

1 the "little" man who owns and operates his own station. Table

TABLE I

Per Cent of Service Stations with managers or manager-owners

in Lubbock, Texas

Type of manager Majors 1 Indep endents

Number |% of | Number of firms;firms lof firms

T

% of firms

Total Number of firms

% of firms

Manager 16 4 8.5 I 10 58.8 26 52

Manager-owner 17 51 .5 41. 2 24 I 48

Total 33 100 17 \ 100 50 jlOO

Ralph Cassady, Jr. and Wylie L. Jones, The Nature of Competition in Gasoline Distribution at the R etail Level, (University of California Press, Berkely and Los Angeles, 1951) p. 81. Hereafter cited as Cassady and Jones, Compet ition at the Retail Leve1.

21

22

I shows that only about forty per cent of the independents

were managed and owned by the same individual. The major

is often considered a company owned station with a hired 2

manager. it was found that over fifty per cent of the

major stations were operated by their owners. Among the

majors it was found that over thirty-three per cent of the

TABLE II

Length of experience of retail service station managers in Lubbock, Texas,

In May, 1958

Length of time

Less than one year

One to two years

Two to three years

Three to five years

Over five years

Total

Majors

Number of firms

9

2

4

3

15

33

% of firms

27.3

6.1

12.1

9.1

45.4

100

Independents

Number of firms

5

4

1

1

6

17

% of firms

29.4

23.5

5.9

5.9

35.3

100

Total

Number of firms

14

6

5

4

21

50

% of firms

28

12

10

8

42

100

p. 71 Cassady and Jones, Competition at the Retail Level.

23

m anagers and manager-owner have been in business two years

or less while over forty-five per cent have been in business

over five years. Among the independents it was found that

TABLE III

Average number of pumps in Lubbock, Texas, by class of service station

Number of Pumps

2

3

4

5

6

7

8

Total

Major s

Number of firms

1

10

11

1

6

1

3

33

% of firms

3

30.3

33. 3

3

18.2

3

9.1

99.9*

Average number 4,48

of pumps

Independents

Number 1 of firms

1

5

6

1

3

1

17

% of firms

3.9

29.4

35 .3

5.9

17.6

5.9

100

4.18

Total

Number of firms

2

15

17

2

9

2

3

50

% of firms

4

30

34

4

18

4

6

100

4.38

* Does not equal 100 due to rounding.

.bout thirty-five percent had been in business over five y*ar.s

It was interesting to note changes in the composition

,f the Lubbock market over the past few years. In 1951 there

24

were 108 majors and 57 independents or 65.45% majors and 34.55% 3

independents. There had been an increase of 24.85% in the

total number of stations by 1958, this growth was made up of

a 27.78% gain in majors and a 19.3% increase in the number of

independents. In 1951 the average number of pumps was 3.11

for majors and 3.91 for independents. The share of total

4 pumps was 60.11% for majors and 39.89% for independents.

The majors in 1958 had an average of 4.48 pumps while the

figure for the independents was 4.18. The share of total

pumps was 67.58% for majors and 32.42% for independents.

The majors had not only increased the relative share of the

market by number of stations but also by the size of the

stations as measured by the number of pumps. In 1951 the

average independent had more pumps than the average major

while in 1958 the reverse was true.

The independent dealers in the regular gasoline market

were maintaining, at the time of this survey, a price differ­

ential below the majors of 2.49^ and the average price of

regular gasoline as indicated by the survey was 30.21^.

Robert M. Castle, "A Comparative Study of Standard and Independent Retail Gasoline Service Stations In Five Cities Unpublished Master's Thesis, Texas Technological College, 1951, Hereafter cited as Castle, "Comparative Study," p. 104.

4 Ibid.. p. 104.

25

TABLE IV

Average price of regular grade gasoline In Lubbock,Texas by class

of service station

Price per gallon

cents

26.9

27.9

28.9

29.9

30.0

31

Total

Average

1 1 Majors

Number of firms

2*

3

11

16

1

33

% of firms

6.1

9.1

33.3

48.5

3

100

30.21

Independents

Number of firms

3

14

17

% of firms

17.6

82,4

100

27. 72

Total

Number

of firms

3

16

3

11

16

1

50

% of firms

6

32

6

22

32

2

100

29.36

*Two majors pricing with independents because of price cuts made May 28 and 29, 1958

It is interesting to note that throughout the market all

independents generally priced below the lowest major for

both regular and ethyl. The exception to this was the price

cutting that began on the last day of the survey when two

of the interviewed major stations dropped the price of regular

ga soline to 27.9<;i which was the price for the highest of the

independents.

In the ethyl gasoline market at the time of the surve-

26

TABLE V

Average price of ethyl grade gasoline in Lubbock, Texas, by class

of service station

Price per gallon cents

28.9

29.9

30.9

31.9

32.9

33.9

34.9

Total

Averag e

Majors

Number of firms

1

6

12

14

33

% of firms

3

18.2

36.4

42.4

100

34.08

Independents

Number of firms

3

6

8

17

% of firms

17.6

35.3

47.1

100

30.19

Total

Number of firms

3

6

8

1

6

12

14

50

% of firms

6

12

16

2

12

24

28

100

32.76

there was an even greater price differential between the

independents and the majors. The average price of ethyl in

major stations was 34.08^ while it was only 30.19^ in the

independent stations, giving a differential of 3.89^. The

av erage for all stations in the market was 32.76^.

The Lubbock market was similar to the conditions de­

scribed in Chapter I in that there were indications that

27

total demand was somewhat inelastic and that some cross-

elasticity as between stations and between the two groups

was present. in answering the query "Did your station ex-

TABLE VI

Change in volume of gasoline pumped in Lubbock, Texas, during

the price war of 1957

Nature of Change

Yes

No

Up

Slight

20-35%

35-5 0%

Down

Slight

20-35%

35-50%

yf=SSS=SSSSSSSS=SS

Majors

Number of firms

24

2

23

12

9

2

1

1

% of firms

72.7

6.1

69.7

36.4

27. 2

6.1

3

3

Independents

Number of firms

9

3

6

3

1

2

3

1

2

% of firms

52.9

17.9

35.3

17.6

5.9

11.8

17.6

5.9*

11.8*

Total

Number of firms

33

5

29

15

10

4

4

1

1

2

% of firms

66

10

58

30

20

8

8

2

2

4

Does not come out even due to rounding.

pcrience any change in volume of gasoline pumped during the

gas war of 1957?" sixty-six per cent of the stations indicated

28

that there was some change in the volume of gasoline pumped.

About 58% of this group indicated that the gallonage increased,

however, over half of these showed only slight increases (possi­

bly only the amount which might be expected with the drop in

price relative to the elasticity of demand). Twenty per cent

indicated a 20 to 35% increase while 8% indicated a 35 to 50%

increase. Thus, it may be stated, on the basis of this sample,

that about one fourth of the market will realize substantial

gallonage increases in a price war similar to the one in the

Lubbock market in 1957, On the other hand about 8% of the

market indicated that they realized a drop in gallonage

during this war. Among the stations indicating a drop in

gallonage, 2% indicated a slight drop, 2% indicated a 20 to

35% drop and 4% indicated a 35 to 50% drop. About 73% of the

majors indicated an increase in gallonage during the war while

only 3% indicated a decline. Over 50% of the independents

indicated an increase while nearly 18% showed a decline. While

it is impossible to show the exact increase in gallonage

during a price war, these data do indicate that while there

is some increase it is not substantial.

Elasticity of demand for the individual station is

shown by the sizable increase in volume of gasoline sold at

some stations during a price war and the similar decline in

volume in other stations. Elasticity is implied in the very

29

existence of a price war as such. If cross-elasticity did not

exist then it would be impossible for a price war to develop.

There would be no incentive for one station to follow the

price cut of another because in the absence of elasticity there

would be no loss or gain and thus no motive for the original

cut. The cross-elasticity as between the groups was not so

clearly indicated in these data. The reason for this was

that in the 1957 price war the independents were able to

maintain about the same relative price differential as they

normally held. This in itself removed all but the "prestige"

incentive for customers to defect to the majors during this

period of low prices. (Informal discussion with some operators

indicated that this was not the case in the 1955 price war.

The majors in that war priced very close to the independents

resulting, as these operators indicated, in a 50 to 75% drop

in volume by many of the independent dealers.)

It may be noted that the Lubbock retail gasoline

market displayed similar characteristics to those described

in Chapter I, p. 2-4. For example there was present a two

price system manifest in the prices of the majors and in­

dependents, total demand appeared to be somewhat inelastic,

and a cross-elasticity of demand seemed to be present both

between individual stations and between the two groups.

Some Disequilibrating For ces

30

The development of excess capacity as a disequilibrating

force in the retail gasoline market has been selected as one

of the theoretical aspects to be compared with the real-world

situation. Thus the study of the local market was conducted

to show either the presence or absence of the development of

excess capacity within its boundaries. There are several

criteria which are more or less pertinent indicators of the

capacity of the market when shown in relative terms.

The number of firms of a given type within a market

area is commonly considered a base for judgement for whether

a market is "crowded." This criterion has some validity

when considering the over-all market situation, but to

show reliability, it must be related to other criteria.

The following comparison in the Lubbock market is of the

number of stations relative to the total population and to the

number of passenger and commercial vehicles. In 1951 there

. were 165 stations in Lubbock composed of 108 (65.45%) majors 5

and 57 (34.55%) independents. In 1958 there were 206

stations in Lubbock composed of 138 (67%) majors and 68 (33%) 6

independents. In 1951 the population of Lubbock was 71,390

Castle, "Comparative Study," p. 104.

6 United States Bureau of the Census, Statistical Ab­

stract of the United States; 1952 (73rd edition) (United States Government Printing Office, Washington 25, D.C.,1952) n. 10.

31

while the 1958 estimated population was 130,000.

In 1951 the average number of Lubbock residents per

service station was 432.67, In 1958, however, this number

had increased to 631.07, indicating a faster growth in popu

lation than in service stations and a relatively larger per

capita market for each station. The number of stations in

Lubbock increased 24.85% from 1951 to 1958, During this

sam e period the market experienced a population increase of

82%. This seems to indicate that the market potential was

increasing much more rapidly than the market capacity. While

the increase of 198.4 residents per station over this period

would seem to indicate that capacity has not increased as

rapidly as demand, other criteria should be examined before

reaching a decision about the question of capacity.

Perhaps the most important measure of capacity within

a market area may be found in the number of consuming units.

Consuming units in the retail gasoline market are the vehicles

employed within the area for transportation purposes. This,

however, does not present a complete picture of the total

mar ket demand. It must be pointed out that vehicles from

outside the market are at times used within the market area

and as a result increase the demand for the product. The

Estimate of the Lubbock Chamber of Commerce, Jan.1,1958

32

a v a i l a b l e d a t a a r e t h e number o f p a s s e n g e r and c o m m e r c i a l

v e h i c l e s r e g i s t e r e d i n t h e c i t y o f L u b b o c k .

In 1 9 5 1 t h e number o f p a s s e n g e r and c o m m e r c i a l v e h i c l e s

r e g i s t e r e d i n L u b b o c k was 4 3 , 2 9 0 or 2 6 2 . 3 6 per s t a t i o n . In

1 9 5 7 , 5 6 , 4 9 7 v e h i c l e s w e r e r e g i s t e r e d g i v i n g an a v e r a g e o f

8 274.26 per station. Thus there was an increase in the number

of vehicles per station over this period.

To examine the situation further, probably the most

valid criterion available to indicate the capacity of the

Lubbock market is an examination of the number of pumps per

station and consuming units per pump. In 1951 there were

3.99 pumps per station while the 1958 survey of the Lubbock

market indicated 4.38 pumps per station, thus, the average

size of the individual station had increased somewhat during

this period. More important, however, was the number of con­

suming units per pump. In 1951 there were 77.44 vehicles

registered per pump but in 1957 there was one pump for each

62.44 vehicles. This seemed to indicate a rather sizable

increase in relative capacity over this interval.

Another indication of the capacity within a market

may be the price changes over this time period. In 1951 the

8 Castle, "Comparative Study," p, 104.

33

average price of regular gasoline was 18.40< before taxes in

the major stations and 15.09<;i before taxes in the independent

9 stations. In 1958 the average price of regular gasoline

before taxes was 22.21^ in major stations and 19.72(;i in in­

dependent stations. In 1951 the national average price of

regular grade gasoline before taxes was 20.3(;i. In February,

1958, the national average price of regular grade gasoline

had increased to 21.8<;i.-'- Nationally then the price of

regular grade gasoline had increased 7.4% over this period

of time. Since 1951, in the Lubbock market, there had been

an increase of 20.7% in the price of regular grade gasoline

in the majors. In the Independents the price increase in

regular grade gasoline over this period was 30.68%.

Probably the best common denominator which will in­

dicate the capacity of the station is the number of pumps

per station. This has increased preceptibly during the

0

United States Department of Commerce, Statisti cal Abstract of the United States, (U.S. Government Printing Office, Washington 25, D.C., 1957='58) p. 550, Per gallon of gasoline in 1951 there was a 4 (;i state and 2<;i federal tax while in 1958 there was a 5<? state and 3<^ federal tax.

United States Department of Commerce, "Survey of Current Business/' (U.S. Government Printing Office, Wash-ington 25, D.C., Ap. 1958) p. S-36.

11 United states Department of Commerce, "1957

Statistical Supplement to the Survey of Current Business," (U.S. Government Printing Office, Washington 25,D.C., 1957)p.l74

34

past seven years. There were 3,39 pumps per station in 1951

while in 1958 there were 4.38 pumps per station or an in­

crease of some 29.2% for the period. At the same time there

had been an increase in the price level of gasoline of 20.7%

in the majors and 30.68% in the independents while the nation­

al average price increased only 7.4%. In the majors there

had been an increase in the average number of pumps from 3.11

to 4.48 or a growth of 44.05% while in the independents the

number had gone from 3.91 to 4.18 for a gain of 6.91%.

It has been pointed out that the number of stations

per capita had decreased during the 1951-1958 interval while

the number of registered vehicles per station increased some­

what. These might seem to indicate that the market had grown

relative to capacity. However, if the number of vehicles per

pump is taken as the most important indicator then the reverse

is more likely to be true as indicated by a substantial de­

cline in the number of vehicles per pump. A further indicator

of excess capacity, pointed out by Chamberlin, is that an ex­

cess capacity becomes evident a result will be a rise in the

price of the product. The Lubbock market has displayed a

m uch greater increase in price of gasoline for this period

than the increase in the national average price. These last

data seem to incicate the presence of excess capacity in the

Lubbock market.

35

TABLE VII

Lubbock stations giving premiums for purchase of gasoline by type of premium given

Type of Pr emium

Stamps

Prize

Dis count

Other

None

Total

- •• \

Majors

Number of firms

14

1

1

17

33

% of firms

42.4

3

3

51 .5

99.9*

Independents

Number of firms

2

6

3

!*•

5

17

% of firms

11. 8

35.3

17.6

5.9

29.4

100

Total

Number of firms

16

7

4

1

22

50

% of firms

32

14

8

2

44

100

* Does not total 100 due to rounding.

** Favors such as pencils, cigars, gum, etc.

The hidden price cut is the second factor which was

considered as a disequilibrating force in the Lubbock retail

gasoline market. These hidden price cuts were defined as any

extra consideration given for the purchase of gasoline.

It was found that over half of the majors gave no price

cut in the form of premiums while this was true of only about

thirty per cent of the independents. The most prevalent form

of hidden price cutting was the trading stamp. Thirty two

er cent of all stations in the market gave trading stamps

^or the purchase of gasoline while 24%

36

gave some other form of

price cut. These other hidden cuts ranged from an actual re­

bate on the price paid for the purchase of gasoline in cash to

such things as cigars, pencils, gum and the like. Fourteen

per cent of the stations interviewed were giving seme type of

prize such as a new car or a boat motor. These were not direct

cuts as found in the other types of hidden cuts but are no less

price cuts in that they were used as devices to induce the

customer into the station to purchase gasoline.

In the total market 56% of the stations gave some type

of a price cut. The major reason for a station to institute

the giving of a hidden price cut was to attract new customers.

It was found that 28% of the stations gave price cuts for this

TABLE VIII

Lubbock stations giving premiums for purchase of gasoline by purpose

Purpose

To hold old

To attract new cus tomers ( .npmon Dracti^.^ other

T^ tal

Majors

Number of firms

2

7 6 1

16

% of firms

6.1

21.2 18.2 3

48.5

Independents Total

Number of firms

7

5*

12

% of ' Number | % of firms |of f irmsj firms

f 1

i 2 : 4

i 41.2 ' 14 28

; 6 12 29.4 6

70.6 1 28

12

56

Three were giving away prizes as advertising measures Two did not know why; they just gave discounts.

37

reason. Of the other 28% which gave price cuts the primary

reason mentioned for giving cuts was to hold their old cus­

tomers (retaliation) rather than try to gain new ones. Retal

iation limits the success of the hidden price cut in incre as

ing trade. Among the stations giving any type of premium for

the purchase of gasoline approximately half indicated that

they have been successful in increasing the amount of gaso­

line sold.

The data obtained indicated that 56% of the stations

in the market practiced some form of "under the board" price

cutting in struggling for a share of the market. As might be

exoected the stations giving a cash discount were the most

successful in gaining the sought for objective, namely, an

increase in volume. This group was quite small relative to

the total market composing only about 4% of the stations.

Twenty-eight per cent of all stations were successful m trie

attempt to increase volume through hidden price cutting. Of

this 28% substantially over half were only slightly success­

ful.

It may be observed that the market conformed to the

general description of a typical market set forth in Chapter

I^ p. 2-4. There is some indication that the individual firm

does face an elastic demand when it can successfully cut its

prices without retaliation. This is indicated by the 10% of

38

•the stations which increased volume from 5 to 25% after the

institution of hidden price cuts. Retaliation was indicated

when other stations within the close proximity of the station

cutting its price also cut their prices in the same manner.

Successful retaliation was indicated when half of the stations

giving any type of premiums pointed out that they experienced

no change in the volume of gasoline pumped at the time they

instituted the practice. It may be safely said then that a

firm faced a relatively elastic demand in the absence of

retaliation but faced a somewhat inelastic demand when re­

taliation was present.

CHAPTER IV

Summary and Conclusions

In the theory of monopolistic competition two dis­

equilibrating factors were considered and the local market

was examined to determine whether these aspects were present

and if they occured as the theory indicated.

The first disequilibrating factor considered was the

development of excess capacity. In the theory it was stated

that if new resources entered the field when a situation of

long-run monopolistically competitive equilibrium prevailed

the result would be excess capacity. This would be manifest

first in severe price competition among the firms and ultimate­

ly in a smaller share of the market for each at a price some­

what higher than would otherwise-prevail.

In the Lubbock market statistics were available to in­

dicate the market capacity in 1951. These indicators were;

(1) the average price of gasoline in both major and indepen­

dent stations; (2) the average size of station in each group

as indicated by the number of pumps; (3) the total number of

stations located within the city limits of Lubbock; (4) the

number of passenger and commercial vehicles registered in

Lubbock; (5) the total population of the city; and (6) the

national average price of regular grade gasoline. A survey

^f the Lubbock market was conducted on May 28,29, and 30, 1958,

39

40

•to determine similar data for that time. A comparison of the

•two sets of data was made and the implications revealed.

It was found that the number of stations had increased

during this period but that there were more vehicles and

people per station in 1958 than in 1956. However, the aver­

age station size as measured by the number of pumps was

somewhat larger in 1958. .Therefore the number of vehicles

and people per pump in 1958 was less than in 1951, indicating

a greater market capacity in 1958, and the price of gasoline

in the Lubbock market had increased substantially more than

the national average price over this period. It was found

that a period of severe price competition manifest in a

"gas war" was generally followed by a price increase which

resulted in prices above those prevailing prior to the war.

Similarities between the theory of monopolistic compe­

tition and the real world situation were present. The theory

stated that new resources entering a long-run equilibrium

SI tuation would result in excess capacity. In the local

market the new resources found in larger more numerous

stations, indicated excess capacity when related to consuming

units. The theory indicated that severe price competition

wo uld occur. The local market has been plagued by "gas wars"

This too conformed to the theory. The theory indicated that

smaller share of the market for each would result in a

41

higher price. Here too the local market conformed. The fewer

consuming units per pump indicated a smaller share of the total

market and the substantial price rise relative to the national

average seemed to bear this out.

It may be concluded that the real-world situation did

seem to conform with the theory of monopolistic conpetition

with respect to excess capacity.

The second disequilibrating factor considered in the

theory was the hidden price cut. The theory of monopolistic

competition indicated that an individual firm could increase

its volume if it could devise some form of a hidden price

cut which would avoid retaliation.. If retaliation were

apparant, however, the result would be either a very slight

or no increase in volume.

wer e

In the local market several forms of hidden price cuts

found to be present. Such things as trading stamps.

prizes, discounts and various premiums such as gum, candy and

cigars were present. It was found that only a few stations

were able to avoid retaliation and thus increase their

volume. The greater portion of the stations were faced with

immediate retaliation and gained nothing by instituting

pr emiums.

In this portion of the theory of monopolistic compe­

tition^ too it seems that the local market conformed by dis-

42

playing gains for some who did not face retaliation and n(

gains for those who did face retaliation.

43

BIBLIOGRAPHY

Bain, Joe S. The Economics of the Pacific Coast Petroleum Industry. Berkeley and Los Angeles: University of California Press, 1944.

Boulding, Kenneth E. Economic Analysis. New York: Harper and Brothers, 1955.

Burns, Arthur Robert. The Decline of Competition. New York: McGraw Hill Book Company, Inc., 1936.

Cassady, Ralph, Jr. Price Making and Price Behavior in the Petroleum Industry. New Haven: Yale University Press, 1954.

Cassady, Ralph, Jr. and Jones, Wylie L. The Nature of Compe­tition in Gasoline Dis tribution at the Retail Level . Berkeley and Los Angeles: University of California Press, 1951.

Castle, Robert Marvin. "A Comparative Study of Standard and Independent Retail Gasoline Service Stations in Five Cities." Unpublished Master's Thesis, Texas Technological College, Lubbock, 1951.

Chamberlin, Edward. The Theory of Monopolistic Competition. Cambridge: Harvard University Press, 1939.

Clover, Vernon T. Business Research. Lubbock: Rodgers

Litho, Inc., 1958. i

Dirlam, Joel B. "The Petroleum Industry," in The Structure ofAmerican Industry, ed. Walter Adams. New York: The Macmillan Company, 1954,

Hamilton, Walton, et_ _al. Price and Price Policies. New York: McGraw Hill Book Company, Inc., 1938.

McAllister, Harry E. "The Elasticity of Demand for Gasoline," in Readings in Current Economics, ed. Morton C. Grossman et al. Homewood, Illinois: Richard D. Irwin, Inc., 1958.

APPENDIX I

Discussion and Analysis of Survey

On May 2S ^ 29, and 30, 1958, a sample survey of the

Lubbock, Texas, retail gasoline market was conducted and com­

pleted. During this period fifty stations were interviewed

and the results of these interviews were tabulated in chart

form in the following sections of this appendix.

Upon completion of the interviewing a "cut-off" analy­

sis was run to determine whether the sample was of adequate

size. A graphic presentation of two of .the questions is pre­

sented to indicate that the answers were falling into a rather

level pattern by the time fifty of the questionnaires were

tabulated.

Question 3: Do you give any type of premium for the

purchase of gasoline?

Percent of Yes Answers

20 30 Numbers

Clover, Business Research, p. 256

44

45

Cuestion 7a: Has there been any change in the price of

gasoline as between the price charged before the war and the

price after the war?

Per cent of Yes Answers

60 50 40 30 20 10

17 IB 30" Number

40 50

is

A further test for the adequacy of size of this sample

found in the standard deviation. This test was applied to

the price of regular grade gasoline and to the number of pumps

in each station. The standard diviation of the price of regular

g rade gasoline was 1.38 and the number of pumps in the average

Stat ion was 1.5

mas

The sample data were compiled by type of station on a

ter questionnaire. The stations which were classed as major

stations are listed in the following chart:

List of Maior Stations

Gulf

Col-Tex

Standard

Texaco

Cono CO

Phillips

Humble

Cities Service

Cosden

The following tables are a presentation of the survey

yestion by question with comments where pertinent about each.

46

Summary Questionnaire

Major Stations

1. How long have you been in the retail gasoline business? (9) Less than 1 year How long in Lubbock? (9)less than 1 yr (2) 1-2 years (2)1-2 years (4) 2-3 years (4)2-3 years (3) 3-5 years (3)3-5 years (15) over 5 years Cl5)over 5 years

2. Compared with other gasoline markets with which you are familiar how would you rate competition in the Lubbock gasoline mar ket? (13) very keen (10) keen (10) moderate ( ) slight

3. Do you give any type of premium for the purchase of gas­

ol ine? (16) yes (17) no (14) stamps ( 1) prize ( 1) discount

4. Why did you start giving premiums? (2) hold old customers (7) attract new customers ( 6 ) common p r a c t i c e (1) other-national advertising

5. When you started giving a premium was there any change in the amount of gasoline sold in your station?

(7) yes (4) slight (2) 5% to 15% (1) 15% to 25%

^^ in your opinion who started the gas wars over the past

two years? (10) independents ( 5) majors ( 3) both ( 5) not qualified (in business too short a period of time) /j O) refused to answer

47

« In your opinion why did they start them? ^11) to increase volume ^ 6) surpluses ^ 3) retaliation

^' Has there been any change in the price of gasoline as between the price charged before the war and the price after the war? 1957 war:

(18) yes (18)

( )

up down

(14) l < ; i ( 4) 2<;i

195 6 war: (14) yes

( 1) H (11) K: ( 2) 2<^

(14)

( )

up down

9. Did your station experience any change in volume of gas­oline pumped during the gas war of 1957? (24) yes (23) up

. (12) slight ( 9) 20-3 5% ( 2) 35-50%

( 1) down ( 1) slight

10. (16) manager (17) manager-owner

11. Price of gasoline: R egular ( 2) 27.9 ( 3) 28.9 (11) 29.9 (16) 30,9 ( 1) 31.0

Ethyl ( 1) 31.9 ( 6) 32,9 (12) 33.9 (14) 34.9

12. ( 1) (10)

(11) ( 1) ( 6) ( 1) ( 3)

Number 2 3 4 5 6 7 8

of pumps:

48

SUMMARY QUESTIONNAIRE

Independent Stations

1. How long have you been in the retail gasoline business? (5) less than 1 year How long in Lubbock? (5) less than 1 yr. (4) 1-2 years (4) 1-2 yrs, (1) 2-3 years (1) 2-3 yrs. (1) 3-5 years (1) 3-5 yrs. (6) over 5 years (6) over 5 Yrs.

2. Compared with other gasoline markets with which you are familiar how would you rate competition in the Lubbock gas­oline market? (4) very keen (4) keen (9) moderate

3. Do you give any type of premium for the purchase of gas­

ol ine? (12) yes ( 5) no ( 2) stamps ( 6) prize ( 3) discount ( 1) other-favors such as pencils, cigars, gum etc.

4. Why did you start giving premiums? ( ) hold old customers ( 7) attract new customers ( 5) other-three are giving away prizes as advertising measures

Two do not know why; they just give discounts.

5. When you started giving a premium was there any change in the amount of gasoline sold in your station?

(7) yes-up (5) slight (1) 5% to 15% (1) 15% to 25%

6. In your opinion who started the gas wars over the past

two years? (4) independents (2) majors

(1) G"^^ (4) not qualified (in business too short a period of time) / ) refused to answer

49

7. In your opinion why did they start them? (5) to increase volume

(1) surpluses (1) income tax

8. Has there been any change in the price of gasoline as between the price charged before the war and the price after the war? 1957 war:

(7) yes (7) up (4) l<;i ( ) down

(1) 2<;i (2) 3<;i

1956 war: (6)yes (5) up (1) down

(3) l<;i (1) l(;i

(2) 2<<

9. Did your station experience any change in volume of gas­

oline pump during the gas war of 1957?

(9) yes (6) up (3) slight (1) 20-35% (2) 35=50%

10. (10) manager (7) manager-owner

11. Price of gasoline: Regular Ethyl ( 3) 26.9 (3) 28.9 (14) 27.9 (6) 29.9

(8) 30.9

(3)

( )

(1) (2)

down siight 20-35% 35-50%

12.

(1) (5) (6)

(1) (3)

(1)

Number of pumps:

2 3 4

5 6 7

LUBBOCK. TEXAS