Taxation and Product Differentiation: The Case of Retail Gasoline

A classic problem in economics is the impact of taxation on market outcomes. Taxes drive a wedge between producer and consumer prices, thereby distorting prices and quantities in a market. In the archetypal case, attention focuses on one homogeneous good. However, in many oligopolistic industries, tax policy may asymmetrically impact goods which are imperfectly substitutable. In such a situation, the separability conditions required for aggregation of untaxed goods into a single numeraire (Deaton and Muellbauer 1980) will fail. Consequently, failure to account for the existence of substitutes not subject to taxation will yield incorrect predictions about the ∗Graduate School of Industrial Administration, Carnegie Mellon University, Pittsburgh, PA 15213-3890. Email address: [email protected]. This paper is a revised version of Chapter 3 of my Northwestern University PhD dissertation. I would like to thank my committee members Robert Porter, John Panzar and Ronald Braeutigam for their assistance and guidance. I would also like to thank MacDonald Beavers for his assistance. Financial support from the Institute for Policy Research, the Transportation Center and the Center for the Study of Industrial Organization at Northwestern University is gratefully acknowledged.