This isn't your parents' demand for gas

Last week, I was doing some background research for a project I'm working on with a couple of chemical engineers and a statistician to try to develop a joint engineering/economic model of the life cycle of transportation fuels.  We were in need of recent estimates of the U.S. demand for gas using national data (monthly consumption and income).  So I sent a message to the ResEcon listserve, a community of 700 or so (I think) environmental economists*. As always, ResEcon came through and I received a fairly recent working paper by a few folks at the Institute of Transportation Studies at UC Davis. 

The findings of the paper are both interesting and troubling for policy design.  The upshot:  Consumption of gas has become dramatically less sensitive to price changes over the past 30 years. 

Here's an excerpt from the abstract:

In this paper, we compare the price and income elasticities of gasoline demand in two periods of similarly high prices from 1975 to 1980 and 2001 to 2006. The short-run price elasticities differ considerably: and range from -0.034 to -0.077 during 2001 to 2006, versus -0.21 to -0.34 for 1975 to 1980.

What does this mean in lay terms?  Between 1975 and 1980, the last period of sustained 'high' gas prices, every time the gas price went up by 1%, the consumption of gas fell by about .28%.**  Not a big decrease, but huge when compared to the estimate for 2001-2006. Over this period, when gas prices increased by 1%, gas consumption fell by only .056%.  That is minuscule. 

What does this mean for policy?  If these estimates hold up for large price changes***--a stretch, but go with me here--it means that a $1.00 gas tax--that is a 33% price increase from a $3 per gallon starting point--will only decrease the consumption of gas by 1.9%.  That is shockingly small. 

As the authors state in the abstract--these results may mean a complete rethinking of the types of policy tools that can be used to reduce gas consumption--if that is the goal:

One implication of these findings is that gasoline taxes would need to be significantly larger today in order to achieve an equivalent reduction in gasoline consumption. This, coupled with the political difficulties in adopting gasoline taxes, suggests that policies and technologies designed to improve fuel economy are likely becoming relatively more attractive as a means to reduce fuel consumption.

I'm not sure I would go that far quite yet.  As I said earlier, using these estimates of the elasticity of demand for large price changes is a stretch.  The way elasticities are derived in these models, the results only hold for marginal (small) changes in prices around the current price.  For larger price changes, we need to consider the long-term ability of consumers to change behavior.  I'm not saying these results are wrong, or that the demand for gas is even remotely elastic, just that for large changes in gas prices, there will be larger changes in consumption behavior then we would observe for the small changes these elasticities are designed to measure. 

Nonetheless, the findings of this paper are surprising and may make some rethink approaches to reducing gas consumption.  On the bright side, this is good news for those politicians who want to use gas taxes to raise revenues for their pet projects. 

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*...and the place John and I go for good economic analysis after we're finished making asses of ourselves here every day. 

**I'm using the mid-point of the range the authors report.

***These estimates are for marginal price changes...not large percentage changes as would be required by the optimal gas tax.

Comments

[John Whitehead]

*I thought our rule was that we're never finished making asses of ourselves?

[odograph]

I think the catch-22 is that when society is ready for rapid change, they will support legislation. When they aren't ready, they won't.

It's not surprising to me that we would not see much "price and income elasticities of gasoline demand" in a period when we as a society aren't too worried.

Some oddballs like me would like us to be more worried and take more action ... but our comments in remote blogs have limited affect.

Stepping back and acting as an impartial observer ... I would guess that if we get concerned the actual dollar amounts for penalties (and their placement, of fuel or auto) will matter less than the societal shift.

If we ever get to the point where gas guzzlers are "bad" we'll be there.

(But you know, every non-environmental economist who defends six year loans on SUVs holds us back ;-)

[odograph]

Oh look, this post at grist is on the same vibe:

http://gristmill.grist.org/story/2007/4/19/152532/524

[Mace]

Can anyone say $15/gallon?

[joshua corning]

This is new news??!?!!?!

I thought pretty early on it was established on this blog that energy has become less and less of an economic consideration in terms of generating wealth...ie in the 70's in order to earn a buck in production you had to spend so many dollars on energy but now that amount of money has dropped considerably in relation to other spending for production...as well as it simply costs less now to earn a buck then it did in the 70's.

Hey I have an idea lets set up a federal maximum wage so that we can cut labor costs to be more in line with 1970's ratio of energy prices and labor costs for production.

Oh wait...never mind, that is exactly what a gas tax is.

[George]

In the short run, there is so little that someone can do to reduce gasoline consumption that of course elasticities will be small.

In the long run you can move closer to work, buy a more fuel efficient car, find a carpool buddy, find a public transit route, etcetera. There are so many more options in the long run that long run elasticity, in theory, should be much greater than short run elasticity.

I don't think that people should focus on short run elasticities in terms of the effects of a gas tax, and this paper says it is looking at short run elasticities (from your quote).

On the flip side, a gas tax could be hugely beneficial, even if people have very inelastic demand for gas, because it could be a huge revenue source and the money could be poured into alternative energy research.

[Ed McClenny]

I seem to remember that there was another factor driving demand down between 1975 and 1980 - we had just ended a period of gas lines and empty stations in the mid 70's as the result of the oil embargo and had a second shortage in 1979 as a result of the Iranian Revolution. You have to add some measure for the cost of time and uncertianty to the price increases in the 75-80 period.

This generated a move to smaller and more economic cars.

[odograph]

"Hey I have an idea lets set up a federal maximum wage so that we can cut labor costs to be more in line with 1970's ratio of energy prices and labor costs for production.

Oh wait...never mind, that is exactly what a gas tax is. "

So what are the ethanol subsidies? The drilling subsidies? The low cost leases of federal lands? The pie in the sky dreams for gasoline replacements?

You may complain about what a gas tax would be, but in our present the government sends a very strong and structured message that you don't have to worry. Ethanol or hydrogen will save you ... and if they don't, they'll divert even more from the general fund (or general debt) to hide the real cost of your fuel.

[joshua corning]

So what are the ethanol subsidies? The drilling subsidies? The low cost leases of federal lands? The pie in the sky dreams for gasoline replacements?

Those are what John and Tim should be advocating getting rid of rather then asking for a tax hike.

I think their response to that would be: "When have we ever said we don't want to get rid of those things?"...and they would be right...but from my personal metric they tend to emphasis the tax more then the ending subsidies angle.

Let me very clear here...I do not mind expensive gas or more expensive energy.

I hate taxes.

[odograph]

They need to join the corn hataz

http://gristmill.grist.org/story/2007/4/17/162758/267

[John Wilson]

I'd appreciate a pointer to any studies looking at "medium-term" price elasticities of demand. My opinion is that the public has gotten "used to" frequent changes in price on the order of 10-30 cents per gallon (in contrast to the 60s when prices were more stable I think). Frankly, I'd be surprised if short-term effects were even statistically significant if medium-to-long term price movements were factored out.

But what happens over periods of 8-16 months when prices shift more persistently? Is there a more significant demand response? That would give a better hint as to whether there has been a change in flexibility.

[Scott Gustafson]

In simple terms, the further up the demand curve you are the more elastic it is, while it is more inelastic lower on the curve.

Between 1975 and 1981 the US went from spending 2.98% of GDP on crude oil going into refineries to 5.24%. In 2001 it was 1.27% and grew to 2.28% by 2005. It looks like about 2.5% for 2006. Apparently we were higher up the curve (with a higher elasticity) in the earlier period than in the latter.

Again, in simple terms it looks like we aren’t spending enough on crude going into refineries, nor on the products coming out for the US consumer to think that they need to do something different.

The big shock was between 1978 and 1981, and the consumers reacted. In 1978 we were refining 15.0 million bpd. By 1983 we were down to 11.9 million bpd. In approximately that same timeframe the price of crude had tripled.

For data, have a look at Gross input to distillation units at http://www.eia.doe.gov/emeu/aer/txt/ptb0509.html

For crude prices see http://www.eia.doe.gov/emeu/aer/txt/ptb0521.html

Another interesting fact. Crude oil going into refineries has been between 19.04 (2005) and 20.08 (1988) barrels per person per year in the US for the last 20 years.

[joshua corning]

Another interesting fact. Crude oil going into refineries has been between 19.04 (2005) and 20.08 (1988) barrels per person per year in the US for the last 20 years.

It is also interesting that rather then a hovering per capita consumption as you imply most people would call it a 5% decline in per capita consumption.

[odograph]

I think for consumption you have to look at finished product sales. There are as I understand it, increasing post-refinery imports.

(Not to say I disbelieve a per capita reduction in consumption. It still may not be as much as I desire.)

[Scott Gustafson]

Actually the number bounces around a bit with no discernable direction. It just happened that the highest number was earlier than the lowest. It’s a really tight range even though the price has been all over the place.

Finished product imports are up but I’m not sure how much on a per capita basis.

[Terrance]

Even slight changes, reducing the work week to cut down on commuting might put a dent in gas demand.