On the road with Elasticity

In this article you can find estimates of both the short run and long run elasticity of gasoline demand. To find the latter, you have to read carefully and apply some of the tools you have just read.

Higher gasoline prices are cleaning out the wallets of motorists but there may be a silver lining: Traffic is somewhat lighter on the heavily congested free ways and surface streets of Southern California

It only makes sense that the sharply higher prices at the pump are leading some people to avoid discretionary trips with their cars, carpooling when possible and shifting to public transportation

Although there are no hard data yet, a broad range of experts say there is evidence that people are buying less gasoline and finding ways to avoid using their cars, contributing to less congestion on the roads.

We have noticed that volumes are lighter than normal, said Frank Quon deputy director of Caltrans freeway operations for Los Angeles County. We haven’t done a study. But we aren’t experiencing as much congestion and travel times are shorter.

Southland public transportation agencies reporting that rider ship has jumped in the first months of 2005 up between 3% and 12% depending on the system.

Anecdotally a lot of people say they are seeing the effect every day which has cut their commute times dramatically. Normally jammed freeways are mysteriously wide open.

If people are indeed cutting back on driving, avoiding discretionary trips, carpooling and using public transportation it should mean that gasoline sales volumes are dropping.

John Felmy chief economist at the American Petroleum institute, the Washington DC trade group that represents the oil industry say that wholesale deliveries of gasoline across the nation are down slightly.

Gasoline prices are up 51 cents a gallon this year across the nation, averaging $2.24 per gallon, Felmy said ‘That’s a 29% increase in price’.

In the short term consumers do not significantly change their driving habits when gasoline prices rise. In economic terms the relationship of prices to sales volume is known a demand elasticity, a 50% increase in price for example lead to a 5% drop in demand according to Felmy.

Using that relationship the 29% increase in gasoline prices this year should lead to a 2.9% drop in gasoline sale volume. It’s to early to tell, however whether that has happened.

During the long term consumers make bigger adjustments reducing their consumption so much that total spending for gasoline stays flat.

During the energy crisis of the 1970s consumers made few immediate adjustments but by the early 1980s they were trading gas guzzlers for fuel efficient cars.

Another major adjustment is likely these days if gas prices remain high, as most oil experts expect. In the mean time, motorists are getting the benefit of spending somewhat les time on congested freeways.

Other Demand Elasticity

Income elasticity of demand

A measure of how much the quantity demanded of a good responds to a change in consumers’ income computed as the percentage change in quantity demanded divided by the percentage change in income.

In addition to the price elasticity of demand economist use other elasticities to describe the behavior of buyers in a market.

The Income Elasticity of Demand: The income elasticity of demand measures how the quantity demanded changes as consumer income changes. It is calculated as the percentage change in quantity demanded divided by the percentage change in income. That is,

Income elasticity of demand = Percentage change in quantity demanded / Percentage change in income

Most gods are normal goods. Higher income raises the quantity demanded. Because quantity demanded and income moves in the same direction, normal goods have positive income elasticities. A few goods such as bus rides are inferior goods: Higher income lowers the quantity demanded. Because quantity demanded and income move in opposite directions, inferior goods have negative income elasticities.

Even among normal goods, income elasticities vary substantially in size. Necessities such as food and clothing tend to have small income elasticities because consumers, regardless of how low their incomes choose to buy some of these goods. Luxuries such as caviar and diamonds tend to have large income elasticities because consumers feel that they can do without these goods altogether if their income is to low.

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