When gasoline prices increase so much, why don’t the amounts purchased fall accordingly? Economists hear that question a lot. After all, we teach students that demand is an inverse relationship between price and quantity.
At low prices, people typically buy a lot. As prices go up incrementally, quantities purchased drop. So why are gasoline sales steady right now?
The answer is that the degree to which quantities fall after price increases varies with the length of time involved. People can make only a few adjustments in the short run, but they can alter their consumption in the longer run. That is particularly true for gasoline.
“Elasticity” is the technical term for the responsiveness of quantity to price changes or vice versa. If the quantities people buy change a lot with price, demand is elastic. But if quantities don’t change much as prices go either up or down, demand is “inelastic.”
Demand for gasoline is inelastic compared with goods that are less of a household necessity. Moreover, gasoline demand is much less elastic over weeks than over years. Given time, households and businesses can do much to reduce energy use, and they do.
Consider typical suburban households where adults commute by car and driving kids to soccer games and music lessons is common. When gasoline prices spike, families have few options in the first weeks or even months. They can try to reduce unnecessary driving by combining errands. Workers might try to carpool with colleagues living in the same area. Parents may take turns with other parents to shuttle children to activities. Those who live close to mass transit might be able to take a bus or train to work.
Even such minor day-to-day adjustments take time to implement. Poor information is a problem. Households do not immediately know about all car-pooling possibilities. Many ride-matching services that employers instituted after previous price spikes withered on the vine with cheap gasoline in the 1990s. Knowledge of carpooling opportunities for school or community events is limited to a small circle of acquaintances.
In the longer run, more information is available and people can double up more often. Households also can sell big vehicles and buy smaller ones. This response takes time. We produce more than 10 million new cars a year, but it still takes more than 10 years for the national fleet of 100 million-plus vehicles to turn over at that rate.
People can also move closer to where they work. Single people might find the combined cost of rent and transportation cheaper in a downtown condo than in a distant suburban town house.
Over time, increased interest in public transit might increase services. This could touch off a virtuous circle in which growing convenience motivates even more people to use transit.
Many adjustments are possible in the long run. This was true repeatedly between 1973 and 1993. But in the short run we just grit our teeth, swipe our card and fill the tank.
© 2005 Edward Lotterman
Chanarambie Consulting, Inc.