Why yes, there is elasticity in the demand for gasoline!

Lynne Kiesling

James Hamilton has done the back of the envelope calculation to show that in the pasat two weeks, gasoline demand has plummeted, both relative to trend and relative to last year. His graph showing the effect is striking.

Professor Hamilton points out that this decrease in demand is one of the reasons why futures prices have returned to pre-Katrina levels, and why the storm hasn’t had more of a prolonged effect on prices.

Retail price fluctuations had their predicted effect; they reduced consumption to cushion and absorb the unanticipated supply shock. How about that?


34 thoughts on “Why yes, there is elasticity in the demand for gasoline!

  1. Prices certainly communicated effectively, despite the whining about “gouging” and “windfall profits” discussed here previously.

    However, in some cases, prices did not rise fast enough to prevent localized unavailability of gasoline at individual filling stations. I know from personal conversations that concerns about driving somewhere and not being able to buy fuel to return home caused both business and personal travel to be deferred.

    The Governor of North Carolina asked residents of the state to stay at home over Labor Day weekend to conserve fuel, just before hopping on a state helicopter to fly to his home at the beach for the weekend. Many North Carolinians honored his request. I suspect similar situations existed elsewhere, which would have contributed to the reduced consumption.

    It will be interesting to watch the trend in fuel consumption over the next quarter, as pipelines, refineries and production platforms come back on line and return to full operation.

  2. Prices certainly communicated effectively, despite the whining about “gouging” and “windfall profits” discussed here previously.

    However, in some cases, prices did not rise fast enough to prevent localized unavailability of gasoline at individual filling stations. I know from personal conversations that concerns about driving somewhere and not being able to buy fuel to return home caused both business and personal travel to be deferred.

    The Governor of North Carolina asked residents of the state to stay at home over Labor Day weekend to conserve fuel, just before hopping on a state helicopter to fly to his home at the beach for the weekend. Many North Carolinians honored his request. I suspect similar situations existed elsewhere, which would have contributed to the reduced consumption.

    It will be interesting to watch the trend in fuel consumption over the next quarter, as pipelines, refineries and production platforms come back on line and return to full operation.

  3. Canada is a net exporter of gasoline. Prices of gas in Canadian cities after Katrina rose 50%, yet Canadian supply and demand was not affected by Katrina. That didn’t stop oil companies here, which peg their prices to the international market or the US market (seemingly, whichever is higher) from jacking up their prices in response to the disaster. It’s gouging, plain and simple.

  4. The Governor of Georgia made the same request. He also suspended the state’s gasoline taxes and announced a crusade against service station price gougers.

    For this he got a column in the Atlanta Journal Constitution proclaiming the week after Katrina his “finest hour.”

  5. The Governor of Georgia made the same request. He also suspended the state’s gasoline taxes and announced a crusade against service station price gougers.

    For this he got a column in the Atlanta Journal Constitution proclaiming the week after Katrina his “finest hour.”

  6. As I recall, both the pipelines going to Georgia’s distributors and the refineries feeding them were down following the hurricane.  Failing to cut fuel use would have meant running dry, and many parts of the state grinding to a halt.

    The fact that the governor would threaten the people working to prevent this with penalties for “gouging” and the AJC would praise him for it says all we need to know about Americans’ economic literacy.

  7. In response to Ade,

    If Canadians will pay higher prices, why shouldn’t oil companies jack up the price? Shouldn’t they be trying to make profits?

    Call it price gouging if you like, but it sounds like common sense to me. As a merchant, you charge what your customers will pay. If the customers don’t buy it, perhaps you are charging too much.

    JBP

  8. In fairness we should note that the Atlanta Journal-Constitution ran a gasoline-related Economics 101 article on September 9 by Scott Beaulier, an assistant professor of economics at Mercer University…

    “If Perdue, Bush and many other politicians around the country are successful in preventing prices from rising, what will be the result? Those who get to the gas station first get gasoline while the rest of us are out of luck.

    “With higher prices, these same consumers would be much more careful with their use of gasoline by carpooling to work, combining their errands and cutting down on extra trips. By conserving when prices are high, there is more gasoline for others.

    “In sum, then, higher prices are just as rational and just as fair as low prices: Both reflect the fundamental forces of supply and demand. Any measures to prevent prices from rising will have a predictable effect: New supplies will not reach those most in need of the resources and shortages will result. For economists, this is a basic microeconomic principle, one that our state and federal leaders would do well to respect.”

  9. This pretty shoddy work. You can’t look at a two week period and determine elasticity. A reduction in consumption might be a result of a distruption in normal business patterns, deferred travel, deferred business, deferred everything. And, in Canada, I can pretty much guarantee that consumption will return to normal even at higher prices.

    Also, was the passing of the labour day weekend considered? That is the end of the driving season.

  10. This pretty shoddy work. You can’t look at a two week period and determine elasticity. A reduction in consumption might be a result of a distruption in normal business patterns, deferred travel, deferred business, deferred everything. And, in Canada, I can pretty much guarantee that consumption will return to normal even at higher prices.

    Also, was the passing of the labour day weekend considered? That is the end of the driving season.

  11. Hi David,

    I will charge any Canadian that wants it, $100 for a gallon of gas. If you “can pretty much guarantee that consumption will return to normal even at higher prices” I will bring you as much $100/gallon gasoline as you can guarantee me a market for.

    JBP

  12. I believe the point about Canadian gas producers is that they sell to an international market, not to a Canadian market first and then to the rest of the world. If the price of gasoline shoots up a dollar south of the border, companies would be fools not to go cash in on the Americans. Americans bid against Canadians for gas, especially along the borders, wherever that gas may come from. If Canadian gas prices did not rise, there would be no reason to supply any gas there when prices are rising in America; send the gas a bit further south and reap the profits.

    This is presumably upseting to those Canadians who think of it as “their” oil going to Americans, while they must pay higher prices. Of course, this is somewhat like expecting a larger bank account when the money supply increases. If it helps, think about the prescription drug situation, where non-price-controlled American consumers are subsidizing…pretty much everyone else.

  13. I believe the point about Canadian gas producers is that they sell to an international market, not to a Canadian market first and then to the rest of the world. If the price of gasoline shoots up a dollar south of the border, companies would be fools not to go cash in on the Americans. Americans bid against Canadians for gas, especially along the borders, wherever that gas may come from. If Canadian gas prices did not rise, there would be no reason to supply any gas there when prices are rising in America; send the gas a bit further south and reap the profits.

    This is presumably upseting to those Canadians who think of it as “their” oil going to Americans, while they must pay higher prices. Of course, this is somewhat like expecting a larger bank account when the money supply increases. If it helps, think about the prescription drug situation, where non-price-controlled American consumers are subsidizing…pretty much everyone else.

  14. The data you are all citing that supposedly shows a large demand drop actually is a measurement of shipments. Normally, shipments should equal demand. But if there was a significant drop in retail inventories over this period the drop in shipments could be a poor measure of change in demand.

    Yes, incentives matter and higher prices cause demand to drop.

    Why should another example of this a big deal?

    Is someone seriously arguing that this does not happen?

  15. If Canada is an exporter of gasoline then the prices paid in Canada will naturally seek equilibrium with those in the export markets unless the price in Canada is regulated. Only in isolation would local supply and local demand seek an independent equilibrium price. It’s a big market, and prices were telling you that. That’s the way it is supposed to work in theory and in practice. So, if that’s gouging, plain and simple, then there must be a pretty low-bar definition of “gouging” to go along with it. Care to share?

  16. If Canada is an exporter of gasoline then the prices paid in Canada will naturally seek equilibrium with those in the export markets unless the price in Canada is regulated. Only in isolation would local supply and local demand seek an independent equilibrium price. It’s a big market, and prices were telling you that. That’s the way it is supposed to work in theory and in practice. So, if that’s gouging, plain and simple, then there must be a pretty low-bar definition of “gouging” to go along with it. Care to share?

  17. And, while we’re at it, the equilibrium price for gasoline in an exporting market should be a little lower than the adjacent importing market, but the difference should be on the order of the transportation cost into the importing market, including any tariffs or taxes applied by the governments.

    Not that I believe in equilibrium… 😉

  18. Elasticity of Demand for Gasoline

    (Note to non-economists: The “price elasticity of demand” is a measure of how much more or less of something people buy in response to a change in price.)

    Most people believe that the demand for gasoline is not very elastic — that is, if the pri…

  19. We need a new thread for the 8-Governors’ letter on price gouging. 🙂 Care to comment?

    I’ll let things go a while before I ask for somebody to define gouging. That seems to be a conversation stopper. 😉

  20. We need a new thread for the 8-Governors’ letter on price gouging. 🙂 Care to comment?

    I’ll let things go a while before I ask for somebody to define gouging. That seems to be a conversation stopper. 😉

  21. Gouging is an asking price well above the market clearing price.

    After Katrina gas prices rose to the $3 to $4 range nationwide. This level of prices allowed supply and demand to balance and profit margins at refiners to rise sharply, that in turn should eventually lead to more refining capacity. The spread between what refiners get for refined products vs what the pay for crude — the crack spread –is now around $10 vs it barely being positive for most of the 1990s. But there were scattered reports of gas in the $4 to $5 range.

    Prices some 150% above the market clearing price should be gouging.

  22. Gouging is an asking price well above the market clearing price.

    After Katrina gas prices rose to the $3 to $4 range nationwide. This level of prices allowed supply and demand to balance and profit margins at refiners to rise sharply, that in turn should eventually lead to more refining capacity. The spread between what refiners get for refined products vs what the pay for crude — the crack spread –is now around $10 vs it barely being positive for most of the 1990s. But there were scattered reports of gas in the $4 to $5 range.

    Prices some 150% above the market clearing price should be gouging.

  23. Thanks so much for the link to James Hamilton’s graph. My students definitely pay attention to gas prices, and will gain better appreciation for the way markets work.

    Simone Wegge
    Associate Professor
    City University of New York

  24. Thanks so much for the link to James Hamilton’s graph. My students definitely pay attention to gas prices, and will gain better appreciation for the way markets work.

    Simone Wegge
    Associate Professor
    City University of New York

  25. So Spencer,

    What if a gas station in Mobile Alabama was having a real hard time getting supplied with fuel? Maybe he had to pay a trucker to go 100 miles out of his way to make a delivery, or maybe he would like to pay the next trucker to go 100 miles out of his way to make a delivery.

    Couldn’t it possibly be that $4 to $5 were a bargain at that point in time? Should price be related to what a customer wants to pay rather than what you want the retailer to charge?

    JBP

  26. Spencer,

    How does anyone determine the “market clearing price” before the market clears?

    Are we talking about local, regional or national market clearing?

    Assuming that the market clearing price is determined to be $3.00 per gallon, are you saying that anyone who charged more than $7.50 per gallon (150% above the market clearing price) was gouging, even though the market clearing price had not yet been determined?

  27. Spencer,

    How does anyone determine the “market clearing price” before the market clears?

    Are we talking about local, regional or national market clearing?

    Assuming that the market clearing price is determined to be $3.00 per gallon, are you saying that anyone who charged more than $7.50 per gallon (150% above the market clearing price) was gouging, even though the market clearing price had not yet been determined?

  28. Prices well above the market clearing price constitute gouging? So, if today a single gasoline retailer in a clearing market increases his price to 2x the market clearing price, then he is guilty of some sort of crime other than stupidity? Or is gouging just a word to describe something that really doesn’t matter or mean much?

    Does it matter what the situation is? When gasoline was 75 cents and plentiful, would $1.50 have been gouging? Or would have just been too high to sell any gasoline? Don’tcha have to have somebody over a barrel before you can gouge’em? Must there not be some sort of emergency? What sort of emergency? A buying panic, or a real supply shortage? Must lives be threatened by this overpricing for it to be gouging? How far from the actual emergency would this rule apply? Does it matter? And who sets these rules?

    It seems to me that if the market clears at a price below the top asking price, then the top asking price is just out of the money. Would there be any “surplus profits” taken? Likely no profits at all. I don’t see a problem here, much less “gouging.”

  29. Gas Prices This Morning

    Good Morning Gentle Readers, Essentially the prevailing wisdom would have us believe that when it comes to fueling the American obsession with the automobile that we will pay the freight regardless of what it costs. Grumbling at the pump to

  30. Gas Prices This Morning

    Good Morning Gentle Readers, Essentially the prevailing wisdom would have us believe that when it comes to fueling the American obsession with the automobile that we will pay the freight regardless of what it costs. Grumbling at the pump to

  31. Gas Prices This Morning

    Good Morning Gentle Readers, Essentially the prevailing wisdom would have us believe that when it comes to fueling the American obsession with the automobile that we will pay the freight regardless of what it costs. Grumbling at the pump to

  32. It seems to me that “gouging” has to be associated with a product that people cannot to do without, such as food or water or some form of shelter, rather than just applied willy-nilly. Outside of required resources, like water, gouging could be applied to things that are required to continue with a way of life at some “subjective” level. By this token, gas prices way above “market clearing” price could well be considered “gouging” if the gas was needed by poor people driving out of Galveston on their way to safety and the gas supply at that station at that time wasn’t unduly low.
    But note the words, “could well be considered”, “unduly”, “could be applied”; these are really political opinions, and not an issue of “economics”, which rightly pays attention to what usually happens with respect to supply and demand. Therefore, when economists get excited about the use of the word “gouging” they should relax; get excited about whether morally or politically something is “gouging” without bringing in economics, which doesn’t have much to say — to my knowledge — about moral judgments, although there is a general conviction that because the rules of a free market approach often produce more goods they are morally advantageous.
    Humans are so varied, that in such situations there is always both “gouging” and “dramatically increased demand relative to supply.” Why are people hung up on a binary choice? Does world generally conform to such interpretations? I say better examine the cases and decide what you think then…..

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