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What's the Price Elasticity of Demand for Gasoline? (Hint: It isn't zero)

What do the studies say?


In response to the ideas advocated by the Pigou Club I've read a number of comments such as the following:
    A rise in gas taxes won't do anything to change people's behavior. Are people going to stop driving to work if prices go up? Are they going to quit their jobs? Are they going to sell their house and move closer to work? Of course not! Higher gas prices do nothing but give the government more of our hard earned dollars.
Of course, one could illustrate all the ways that someone could cut back on fuel consumption in response to higher prices, such as carpooling, going to the supermarket and the post office in one trip instead of two, and so on. What we're really debating is - what is the price elasticity of demand for gasoline? Is it zero? That is, if gasoline rises 10%, what happens to the quantity demanded for gasoline? We do not have to just theorize about how people may respond to a rise in gas hikes, we can look at studies which determine what the price elasticity of demand for gasoline is.

It turns out that there are a lot of studies which calculate what the price elasticity of demand is. There seems to be at least 100. Fortunately there are two good meta-analyses which examine the work of many different studies on the matter.

One such study is Explaining the variation in elasticity estimates of gasoline demand in the United States: A meta-analysis by Molly Espey, published in Energy Journal. Espey examined 101 different studies and found that in the short-run (defined as 1 year or less), the average price-elasticity of demand for gasoline is -0.26. That is, a 10% hike in the price of gasoline lowers quantity demanded by 2.6%. In the long-run (defined as longer than 1 year), the price elasticity of demand is -0.58; a 10% hike in gasoline causes quantity demanded to decline by 5.8% in the long run.

Another terrific meta-analysis was conducted by Phil Goodwin, Joyce Dargay and Mark Hanly and given the title Review of Income and Price Elasticities in the Demand for Road Traffic. A PDF file of the study is available here. If you're interested in the subject, it's an absolute must-read. They summarize their findings on the price-elasticity of demand of gasoline as follows:

    If the real price of fuel goes, and stays, up by 10%, the result is a dynamic process of adjustment such that:

    a) The volume of traffic will go down by roundly 1% within about a year, building up to a reduction of about 3% in the longer run (about five years or so).

    b) The volume of fuel consumed will go down by about 2.5% within a year, building up to a reduction of over 6% in the longer run.

    The reason why fuel consumed goes down by more than the volume of traffic, is probably because price increases trigger more efficient use of fuel (by a combination of technical improvements to vehicles, more fuel conserving driving styles, and driving in easier traffic conditions). So further consequences of the same price increase are:

    c) Efficiency of use of fuel goes up by about 1.5% within a year, and around 4% in the longer run.

    d) The total number of vehicles owned goes down by less than 1% in the short run, and 2.5% in the longer run.

It's important to note that the realized elasticities depend on factors such as the timeframe and locations that the study covers - the realized drop in quantity demanded in the short run from a 10% rise in fuel costs may be greater or lower than 2.5%. Goodwin et. al. find that in the short-run the price elasticity of demand is -0.25, with a standard deviation of 0.15, while the long rise price elasticity of -0.64 has a standard deviation of -0.44.

While we cannot say with absolutely certainty what the magnitude a rise in gas taxes will have on quantity demanded, we can be reasonbly assured that a rise in gas taxes, all else being equal, will cause consumption to decrease.

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