Alan Krueger's NYTimes Economic Scene column deals with gasoline demand elasticities and policy (Why the Tepid Response to Higher Gasoline Prices?). He finds that the recent response to high gas prices is unusually low. Noting that short run (about one year) demand elasticities are between .1 and .2:
Most studies find that a 10 percent increase in gas prices in a year is associated with a 1 to 2 percent drop in the quantity of gasoline purchased in that year.
He is surprised that the current change in consumption is smaller than in the past:
Recent experience suggests a more muted response. From September 2004 to September 2005, the average retail gasoline price jumped to $2.90 a gallon from $1.87, or 55 percent, according to the Energy Information Agency. Yet gasoline consumption dropped only 3.5 percent, to 8.83 million barrels a day in September 2005 from 9.15 million barrels a day in September 2004 ...
These numbers give us a demand elasticity of .06. This is less than the .1 lower range that we have seen in the past. But my guess is that the demand elasticity of .06 will rise as consumers have more time to adjust to the most recent price spike. As the graph from the EIA shows we've only had three months of $2.50+ gas. I'll be interested to see the gasoline consumption numbers in September 2006 if gas prices stay about $2.50.
Also, Krueger notes other reasons why the short run gas demand may be falling over time. First, consumers may see the recent gas spike as temporary -- no reason to change behavior (much). Second, car companies discount big cars when gas prices rise. Third, as income has risen in the US the share of the household budget devoted to gasoline has fallen.
Interesting, yes, but the kicker are the policy implications:
A change in the way people respond to gas prices affects policy. A 2003 study by the Congressional Budget Office considered two ways to reduce gas consumption by 10 percent: a 46-cent increase in the gas tax and stricter average fuel economy standards, which penalize automakers if their fleet fails to achieve a specified number of miles per gallon. The study found that the tax cut consumption at a slightly lower cost to society.
But if consumers cut consumption less in response to higher gasoline costs than they used to, the balance would tilt more toward stricter mileage standards for automakers.
In August, Transportation Secretary Norman Y. Mineta made a step in this direction by proposing stricter standards on S.U.V.'s, pickup trucks and minivans.
He could curb gasoline use further and close a loophole by placing miles-per-gallon standards on vehicles that weigh 8,500 to 10,000 pounds when loaded, like the Hummer H2. Of course, a gas tax has an advantage over fuel efficiency standards: it raises revenue, and even more so if demand is less responsive to gas costs. A higher gas tax would also immediately affect drivers of existing cars and afford flexibility, whereas stricter mileage standards would affect only new cars and would rigidly apply to all carmakers.
But tougher fuel efficiency standards and a gasoline tax increase are not mutually exclusive. Indeed, consumers would probably complain less about a higher gasoline tax if their cars got more miles to the gallon.
I'm still on the gas tax bandwagon. I think the recent low demand elasticity is only a blip and that, over time, consumers will respond to the higher gas prices by driving less, buying smaller cars, etc.
