Inelastic gas

Tag : Fuel Oil Gas

With the sharp rise in the price of oil, everybody expects a bigdrop in consumption of oil products. At the gas pumps, for example,the increase in the price of gasoline over the last two years isnow similar to the magnitude of the increases in the 1970s andearly 1980s. Will consumers today dramatically change theirbehaviour as they seem to have done 30 years ago?
Conventional wisdom says they will. So do the proponents of carbontaxes. Put a big carbon tax on gasoline, they say, and consumerswill stop using gasoline to such a degree that carbon emissionswill decline dramatically. Statistics Canada retail sales datareleased this week appear to show a change in gasoline demand.Certainly that's how the media reported the numbers. But isgasoline and oil consumption falling dramatically, as implied bythe headlines and theory?
In economics, the degree to which consumers will respond to a pricechange in a product is called its elasticity. If the price ofgasoline rises by 50%, and consumers cut their use of gasoline by50%, gasoline would be considered a very price elastic commodity.If consumers can react quickly, demand is elastic, otherwise it isinelastic.
There are many reasons to be skeptical of claims that a carbon taxor a equivalent rise in oil prices will cause drastic changes inconsumption patterns. Despite the hype, the rise of oil prices hasnot been matched by correspondingly sharp declines in demand. Thissuggests inelasticity. Even if prices go up, demand remains strong.Gasoline, it turns out, is a very inelastic commodity in the shortrun. It may be more elastic with time, as people move slowly toadapt to the new price levels. Let's put it this way: It may take alot of time for a carbon tax or the price rise in gasoline to havea dramatic impact on demand and, thus, carbon emissions.
Looking at data from the United States, we can compare the impactof rising gasoline prices today with the oil shock years of the1970s. Today, Americans spend 7% of their income on gasoline. Inthe 1970s, they spent twice as much. Part of the reason for that isincreased fuel efficiency. The U. S. Energy Information Agencystatistics show that the composite motor vehicle fuel rate (trucks,SUVs and passenger cars) in miles per gallon rose 42% from 1973 to1991. As for the passenger car alone, since 1973 it's fuelefficiency has gone up by 71%. This efficiency gain is bound tohave a significant impact on consumption and the price elasticityof gasoline.
Put another way, gasoline as a percentage of the total cost ofowning a car dropped from 33% in 1975 to 17% in 2006. At the sametime, the real income of Americans has increased by 60%. Since the'70s, the amount of energy needed to produce one dollar of GDP hasgone down by 51% from 1970 to 2007 (see graph 2). We produce morewith less energy. These two factors combined--less fuel use andricher consumers -- mean that the incentive to cut fuel consumptionis much less than it was in the 1970s.
If gas takes a smaller share of the budget of American consumers,it means that prices changes like those we see now will not affectconsumers as it did before. Sure, consumers are reacting bychanging some of their consumption patterns: public transit usagehas gone up, people are switching to smaller vehicles and drivingless. But not by much. Travel on all roads and streets decreased by1.8% for April, 2008, as compared to April, 2007, according to theFederal Highway Administration. During that time, the price ofgasoline rose 75%, suggesting a severe degree of inelasticity. Fuelconsumption averaged 20.4 million barrels a day in the four weeksended June 6, 2008, down 1.3% from a year earlier. On top of this,since April, 2006, the total driving distance by all Americans hasbeen going down, but only by 2.6%. But which part of these smalldeclines can actually be attributed to rising oil prices? We are,clearly, in some kind of economic slowdown. Is the truck businessdeclining because of gas prices, or because of the meltdown in U.S. housing activity, where small trucks play a big role? Aneconomic slowdown in the United States (or a recession according tosome) may be driving gasoline consumption even more than price. Themodifications on the consumer side are undeniable, but they are notstrong.