Rockets and Feathers

Note : If you like the article, please do press the heart either above or below the article in this email (LIKE it), it will help my stack reach a wider audience on substack. I deeply appreciate your help. I started on 12/02/23, and six months in, my stack reached 100 readers - I deeply appreciate your support as I continue to grow. I mostly write this because I love finance, probability and statistics, and economics, but from the comments and feedback I get, I realize you all love it too. A very special thank you to Jon, who gave me my first break, by introducing me to his readers on his Sports Illustrated column. Thank You for being so kind

When the price of corn increases, the price of breakfast cereal increases in response, and when chickens get sick and die due to avian flu, the price of a carton of eggs increases in response

When the price of lithium increases, a resultant increase in the price of lithium-ion batteries leads to an increase in the price of electric vehicles

Price is about a lot of things – such as average cost, marginal cost, profit margin, market power, understanding your customer willingness to pay, and whether the product is sold in a competitive market or not, but – one of most underrated aspects of pricing is – human psychology

Once we get used to a higher price, we just get used to it, and sellers know this and do take advantage of it

In economics, we call this – Rockets and Feathers

Below,

Price of gasoline, blue line, in $/gallon (left y axis)

Price of crude oil, red line, in $/barrel (right y axis)

When the price of crude oil increases, it is only fitting the price of gasoline increases – if the gasoline producers want to maintain their profit margin as before

So, when the price of crude increases, the price of gasoline increases along with it, and quite swiftly too – like a rocket

But, when the price of crude begins to decrease after market conditions have stabilized, then the price of gasoline decreases, but at a much slower pace …

You know, like a feather … as it comes down

You can see this yourself, on the left hand side, the blue line increases steeply, but on the right hand side, the blue line decreases at a much slower pace. The price of gasoline certainly did not come back to its lowest level as before, even as the price of crude went back to its lowest level as before

We economists do need to get paid, so as opposed to calling this rockets and feathers, we call this – asymmetric pass through of prices

It just sounds fancier

It just means the gains upstream (such as the decrease in the price of crude), is not always completely passed on to the customer (manifesting itself as a decrease in price of gasoline)

How competitive a market is would drive how much of the gains are passed on. Think about it intuitively, if you keep gasoline prices high even when crude prices have gone back to normal levels as before, and if all your competitors have passed on more of those additional gains to customers, then people would simply buy from your competitors. You’ve priced yourself out of the market

Banks also behave the same way at times. They follow the increasing interest rates set by the Federal Reserve like a rocket, but are rather laissez-faire (as in, laidback) when the federal reserve decreases interest rates, and now, they (the banks) need to decrease lending rates to customers (reference : The Guardian)

Source : Federal Reserve Economic Data (FRED), The Guardian, Additional Resource : MIT