This week, Reid Taylor presented his recent research, which delves into the impact of entry and market power on fuel prices in California. This study was prompted by recent policy changes aimed at limiting the establishment of new gas stations in specific areas across the state. These policies, designed to curtail carbon emissions, are expected to exert an influence on the market power of existing fuel retailers and, in turn, the prices of fuel for consumers.

With the overarching goal of estimating the effects of these policies, Reid employed a recently developed econometric technique to determine the causal effect of a new entrant entering a local market on gas prices. Estimating the impact of a new entrant on prices is a complex task because a firm's decision to enter a market is often contingent on prevailing prices. This creates a sort of "chicken and the egg" dilemma: Did changes in prices trigger the firm's market entry, or did the firm's entry into the market drive price changes?

To address this challenge, Reid circumvented the issue by leveraging high-frequency time series data on gas prices. The process of opening a new gas station is a protracted one involving planning, permitting, and construction, and these decisions are primarily driven by long-term incentives. In contrast, gas stations can swiftly and easily adjust their gas prices in response to the arrival of a new competitor in the market. Due to this disparity in the timeframes involved, we can reasonably assume that changes in prices occurring shortly after a new station opens are, in fact, caused by the new entrant rather than the other way around.

Utilizing this innovative technique, Reid discovered that, on average, the opening of a new gas station led to a 2-cent reduction in the price per gallon at other stations within a 1-mile radius, which corresponded to a 5% reduction in profits.