The Demand for Gazolene/ Petrol

The Demand for Gazolene/ Petrol

By Mike Moffatt

Updated June 09, 2016.

A rise in gas taxes won't do anything to change people's behavior. Are people going to stop driving to work if prices go up? Are they going to quit their jobs? Are they going to sell their house and move closer to work? Of course not! Higher gas prices do nothing but give the government more of our hard earned dollars.

Of course, one could illustrate all the ways that someone could cut back on fuel consumption in response to higher prices, such as carpooling, going to the supermarket and the post office in one trip instead of two, and so on. What we're really debating is - what is the price elasticity of demand for gasoline? Is it zero? That is, if gasoline rises 10%, what happens to the quantity demanded for gasoline? We do not have to just theorize about how people may respond to a rise in gas hikes, we can look at studies which determine what the price elasticity of demand for gasoline is.

It turns out that there are a lot of studies which calculate what the price elasticity of demand is. There seems to be at least 100. Fortunately, there are two good meta-analyses which examine the work of many different studies on the matter.

One such study is Explaining the variation in elasticity estimates of gasoline demand in the United States: A meta-analysis by Molly Espey, published in Energy Journal. Espey examined 101 different studies and found that in the short-run (defined as 1 year or less), the average price-elasticity of demand for gasoline is -0.26. That is, a 10% hike in the price of gasoline lowers quantity demanded by 2.6%. In the long-run (defined as longer than 1 year), the price elasticity of demand is -0.58; a 10% hike in gasoline causes quantity demanded to decline by 5.8% in the long run.

Another terrific meta-analysis was conducted by Phil Goodwin, Joyce Dargay and Mark Hanly and given the title Review of Income and Price Elasticities in the Demand for Road Traffic. If you're interested in the subject, it's an absolute must-read. They summarize their findings on the price-elasticity of demand of gasoline as follows:

1If the real price of fuel goes, and stays, up by 10%, the result is a dynamic process of adjustment such that:a) The volume of traffic will go down by roundly 1% within about a year, building up to a reduction of about 3% in the longer run (about five years or so). b) The volume of fuel consumed will go down by about 2.5% within a year, building up to a reduction of over 6% in the longer run. The reason why fuel consumed goes down by more than the volume of traffic, is probably because price increases trigger more efficient use of fuel (by a combination of technical improvements to vehicles, more fuel conserving driving styles, and driving in easier traffic conditions). So further consequences of the same price increase are: c) Efficiency of use of fuel goes up by about 1.5% within a year, and around 4% in the longer run. d) The total number of vehicles owned goes down by less than 1% in the short run, and 2.5% in the longer run.

It's important to note that the realized elasticities depend on factors such as the timeframe and locations that the study covers - the realized drop in quantity demanded in the short run from a 10% rise in fuel costs may be greater or lower than 2.5%. Goodwin et. al. find that in the short-run the price elasticity of demand is -0.25, with a standard deviation of 0.15, while the long rise price elasticity of -0.64 has a standard deviation of -0.44.

While we cannot say with absolute certainty what the magnitude a rise in gas taxes will have on quantity demanded, we can be reasonably assured that a rise in gas taxes, all else being equal, will cause consumption to decrease.

Elasticity

Either consciously or subconsciously, the issue of elasticity surfaces for consumers and producers in many everyday, real-world situations. Let's examine some of these situations and the main factors that determine the degree of elasticity of demand. These factors are:

2Availability of substitutes

3Short-run versus long-run

4Percentage of income spent on the product

Availability of Substitutes

Overall demand for gasoline—at least in the United States—is generally considered relatively inelastic. Americans own cars and trucks, and the country is large and laced with highways. Americans need gasoline because there are few substitutes for it. In fact, the only real substitutes are public transportation, which is not always available, and the electric car, which is still a relatively new technology.

However, any individual consumer's demand for gasoline can be elastic or inelastic, depending on their access to a substitute. Suppose the price of gasoline were to double over the next two months. If you commute from a suburb into New York City or another city with good public transportation, you could start taking the bus or train to work and dramatically reduce your demand for gasoline. Your demand for gasoline is relatively elastic.

On the other hand, if you commute from your home in one suburb to an office campus in a distant suburb, your transportation options may be quite limited. You need gasoline, and therefore your demand for it is relatively inelastic.

If there are few substitutes for a product, the demand for it is relatively inelastic. That means that the price can change, but the quantity demanded doesn't change very much in response.

Short-Run Versus Long-Run

The long-run and a short-run demand for many goods and services can differ substantially, and that affects elasticity.

In our gasoline example, a driver whose demand for gas is inelastic in the short-run may have elastic demand in the long run. She may find a job or start a business closer to home, or start a home-based business. She might buy a more fuel efficient car, or—in an instance of substitution—buy an electric car when her vehicle needs replacement.

For most products and services, long-run demand is far more elastic than short-run demand. As a fossil fuel with a finite supply, gasoline itself will be unavailable in the long run. Over the long run, people can make any of a number of adjustments that will alter their demand for a good.

In the short run, however, inelasticity tends to prevail, relative to the long run.

Percentage of Income

The higher the percentage of income that a product or service consumes, the higher the elasticity. The lower the percentage of income, the lower the elasticity. For example, if the price of Tic Tacs goes up by 10 percent I doubt that many consumers of the mints would alter their demand for them. It's partly because the percentage increase would occur on a small base price relative to other common purchases, such as food, clothing, and gasoline. But it's also because the money spent on mints is a tiny percentage of most people's incomes.

Demand for items purchased with a small percentage of people's incomes is fairly inelastic. Price changes don't have a big effect on the quantity demanded. By that same token, cutting the price would probably do little to stimulate demand.

Things that people spend a higher percentage of their incomes on, such as cars, have higher elasticity of demand. People will consistently seek out the best deal on a new car or buy a used car because the price represents a relatively high percentage of most people's incomes. Some people never buy a new car, only used ones. Meanwhile, few people are shopping for the best deal on Tic Tacs (or are willing to accept used ones).

Elasticity is worth knowing about because, first, it explains a lot of consumer behavior and, second, it lays the groundwork for understanding other aspects of consumer purchase decisions.