Different River

”You can never step in the same river twice.” –Heraclitus

September 20, 2005

Elasticity of Demand for Gasoline

Filed under: — Different River @ 6:27 pm

(Note to non-economists: The “price elasticity of demand” is a measure of how much more or less of something people buy in response to a change in price.)

Most people believe that the demand for gasoline is not very elastic — that is, if the price of gasoline increases, people will still buy the same amount. Most economists agree, only the would say, “Demand for gasoline is inelastic.” As my students said when I was teaching introductory economics, “You still have to go to work.” (My response: “Yes, but you don’t have go everywhere you drive, you can combine, trips, you can carpool — and even if you personally can’t, someone can, and that’s enough to reduce the population’s demand for gasoline.”)

It turns out that the demand for gasoline does actually have some elasticity in it. James Hamilton of EconBrowser shows that the recent run-up in gas prices actually has reduced the quantity of gasoline consumed — both from level before the increase, and the level at the same time last year (so what we are seeing is not merely a seasonal effect.) He even has a great chart showing the prices this summer and last summer. (Hat tip: Knowledge Problem.)

So, people are actually driving less. If the higher prices persist, we should see the demand drop even further. The reason for this (which in econospeak is, “Demand is more elastic in the long run than in the short run”) is that in the short term, the only way to change your gas consumption is to drive less, which usually means going fewer places. In the long run, you can buy a more fuel-efficient car, move closer to work, or make other adjustments that reduce the amount of gas you consume.

Meanwhile, over at Tech Central Station, James Glassman makes nearly — but not quite — every error imaginable in discussing the relationship between fuel efficiency and fuel consumption. His article is entitled, “10 MPG: The Road to Energy Independence” and his basic point is that increased fuel efficiency leads to increased fuel consumption if people drive more. Now that may well be true, but Glassman hasn’t proven it.

It is true that if demand for “miles driven” is sufficiently elastic, a decrease in the cost of driving in dollars per mile — which could be accomplished through in increase in fuel efficiency — could increase the total amount of fuel consumed. But all Glassman has done is shown that over the 30 year from 1973-2003, fuel efficiency has increased and the total amount of fuel consumed in the entire United States has increased, as has the total number of miles driven in the entire United States.
This ignores several key variables. For example:

  • The population of the United States has substantially increased during that time period. Surely if we have (say) 40% more people, and we drive 40% more miles, shouldn’t that be attributed to something other than the effects of increased fuel efficiency.?
  • The price of gasoline has been changing over that period. In fact, the inflation-adjusted price of gas was lower in the mid-1990s than in 1973. When the price of gas drops, people drive more. (This is precisely the reverse of what James Hamilton showed above — driving lesswhen the price is high is equivalent to driving more when the price is low.)
  • The reason for this is that people don’t really care about the price of gas for its own sake, or for fuel economy for its own sake. The key factor is, how much, in dollars, does it cost to get where you want to go? This cost drops if the price of gas drops, your car’s fuel economy increases, or you start out closer to your destination (e.g., move closer to work).

Any analysis of the long-run effects of fuel economy has to take all these factors into account. To determine the true effect of fuel economy on driving, we should convert the fuel economy from miles per gallon into dollars per mile driven, per person, and see how that changes with respect to fuel economy.

Glassman doesn’t do that; he just takes the total number of miles driven and sees that it increases, and concludes that improving fuel economy increases oil imports. We shouldn’t be surprised then, but the fact that even the title of his article is wrong: back when the average really was 10 MPG, we didn’t have energy independence. Why does he think that’s different now?

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