The Varied Effects of Gasoline Prices

A recent article in the NY Times concerning the price of gasoline caught our attention because it touched on so many concepts related to the demand for gasoline. (Click here for article)

An increase in gasoline prices will cause different people to react in different ways. Some will be forced to pay the higher prices and cut down on their consumption of other goods. Others will be able to change their lifestyles and reduce their consumption of gasoline. One thing is certain; as the price of gasoline rises, people purchase less gasoline. The only question is, by how much?

Economists use the concept of elasticity to measure the responsiveness of consumer purchases to changes in price. Over relatively short periods of time, consumers can generally not react and we say that demand is inelastic, meaning unresponsive. The NY Times article quotes a MasterCard source that says consumption of gasoline has fallen by 1% over the last year. The US Energy Information Administration reports an increase in gasoline prices of 38% over the same period. The elasticity measure is (-)0.026, indicating an inelastic demand – consumers, in general, are not reducing their consumption of gasoline significantly.

When prices rise, and consumers continue to purchase gasoline, the consumption of other goods must fall. Consumers are worse off since the price increase reduces the purchasing power of their income. We should expect the demand for normal goods to fall and the demand for inferior goods to rise. There is evidence of this at the True Value hardware store, where sales of replacement parts (an inferior good) have increased.

Over longer periods of time, more consumers can change their consumption, and elasticity increases. People become more responsive to the price change. This is usually a result of people simply not being able to respond in the short run. A person with a 50-mile (80 km) round trip commute can change jobs, relocate, or purchase a small vehicle. None of these options may be possible in the short run. If gasoline prices remain high, we would expect to see the sales of smaller vehicles increase first and then perhaps see people moving closer to their place of employment. These are long run responses.

Consumers’ response to changing prices depends on whether or not they can easily change their spending patterns. In the short run they may not be able to change and thus the demand appears to be relatively inelastic. Over a longer period of time, if prices stay high, consumers will respond and demand becomes more elastic. Evidence of this behaviour can be found in this article.

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