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elasticity conversion point

By enelson
Monday, April 23rd, 2007 at 5:09 pm in driving, Environment, Transit vs. driving.

gas-prices-up-to-april-2007.gif

It’s finally happened!

We’ve reached the elasticity conversion point!

According to a leftover press release I found floating in the piles of pulp on my desk (I was on jury duty; let me do the judging here.), gasoline consumption in California dropped for the first time since 1992.

In econo-speak, we are such slaves to our internal combustion climate-changers that demand for gasoline doesn’t follow the standard economic model. Normally, prices get very high for a commodity, people buy less of it. Gasoline, however, is inelastic, so we have for decades continued to buy the same amount when prices were down as we did when they seemed way too high.

Those who follow the ups and downs of gasoline prices have wondered, then, how ridiculously high prices would have to go before demand started to flex a bit, i.e., the elasticity conversion point.

In short, we’ve felt the pain and we’re there.

Only in California were gas prices close to or above $3 for the nine months that ended in December. While the rest of the nation continued to slurp up petrol, California cut back a little. It’s just 1 percent, but it shows a convincing (to me, anyway) link between $3+ gas prices and consumption.

We drove less for a change. We started driving hybrids. We got new tires. I don’t know how it happened, but I know that it did.

Perhaps the oil companies, as some conspiracy theorists will suggest, have been probing to find that conversion point. If so, they found it. From here, the theory dictates that they will now have to back off the price so it’s just a tick below $3 all the time.

I’m not much for conspiracy theories, however, except the one about the election. That one’s hard to shake. What I do believe is what I read in the newspapers, which tell me that oil production isn’t going to get much better than it is now, but demand is going to keep going up, if not in California, in China, India and the developing world.

As dire as that sounds, it means that here in California, and soon in other parts of the world’s biggest CO2 producer, people will find ways to do more with less.

Graph from www.eia.doe.gov.

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11 Responses to “elasticity conversion point”

  1. murphstahoe Says:

    I’m not buying it. While I can see it leveling off, I don’t think we’ve come anywhere close to the knee of the curve where price increases would correlate to drops in demand based on basic microeconomics. I predict the real “pain” that would get most Californians out of their car is $7…

  2. Frequent Amtrak Rider Says:

    I agree with the poster above, except I’d put the cost somewhere closer to $5. The good news is that the sales of SUVs are down.

  3. Marcel Marchon Says:

    > The good news is that the sales of SUVs are down.

    Well, isn’t that an indication already? Why would people stop buying big fat cards all of a sudden? Did they just get concerned because of all that talk about Global Warming? Or was it maybe the gas price after all?

  4. Capricious Commuter Says:

    Murphstahoe and FAR, I agree that major change won’t occur until prices get somewhat higher. The point I’m making is that until this point, there was NO relationship between prices and demand. None, zero. Now there is SOME effect from $3+ gas. That’s a turning point, in my book.
    And as Marcel suggests, car-buying habits are also and indicator that change is afoot. The whole hybrid craze pretty much blindsided the auto industry. But car-buying is unlike gas buying in two important respects. One, it tends to change pretty quickly when a new trend pops up, like compacts of the 1970s, minivans of the 80s and SUVs of the 90s and beyond. It’s beginning to look like hybrids and other alt-powered vehicles will be the craze of the late 00s.

    Another unstated factor in my thinking was my contact with old colleagues from LA, where people who aren’t transit-dependent are actually starting to ride buses. There’s only so much grief people can take before they look for alternatives. One of them, to whom I sold a perfectly serviceable Toyota Camry, told me she now takes the subway and Rapid Bus for her 25-mile commute. When I worked there five years ago, that was considered lunacy to the vast majority of Angelenos. Now people get it, even if they aren’t ready to make that jump themselves.

  5. South Bay Resident Says:

    Here’s a thought on gas prices and elasticity:

    It makes no sense to replace just about any car with a new one before it is ready to be retired to save on fuel costs. Even if you sell your 15 MPG SUV and buy a Puius somebody is still going to use it until it dies (which is like 250k miles these days). Thus, in the short run, the only way you’re going to see changes in gasoline usage is through behavior shifts (carpooling, taking transit, avoiding trips) These shifts are often painful or very expensive (I could save $2/day at current gas prices by taking the bus, but it would cost me 90 mins, and believe me, I make far more than $1.33/hour).

    I expect that $2.50/gal gas was enough to motivate people to change their vehicle buying habits, but that seeing the results of this change will take several years.

  6. Michael Krueger Says:

    No discussion of “high” gasoline prices truly makes sense without adjusting for inflation. Please look at this graph of real (inflation-adjusted) gasoline prices from 1919 to 2008, published by the Department of Energy. As you can see, real gasoline prices are high, but still well short of their late-1970′s peak. In fact, the overall trend since 1919 has been falling real gasoline prices, with three notable peaks corresponding roughly with World War II, the OPEC crisis, and the current Iraq war.

    I find it very hard to believe that $3-a-gallon gasoline is going to get many Americans out of their cars, given that citizens in other industrialized countries already pay up to twice that amount and still drive. However, if real prices reached the $7 level we might finally see people owning fewer cars, choosing more fuel-efficient models, and driving less, just as they do in countries where gasoline costs that much today.

  7. murphstahoe Says:

    The troublesome thing is that we’ve had such cheap gas that we’ve not prepared for not-so-cheap gas. So now, the cost of “Not Driving” is high – in terms of convenience.
    For me, my 90 minute nominal trip to work on bike and Caltrain is fine – I get 30 minutes of “free” exercise – while many pay for a gym, spend time going to and from the gym (which somehow is not as annoying as the time I spend on Caltrain) and I never *don’t* get my exercise. I can barely finish reading the Chronicle on the train portion of my commute – and I consider that reading very important. And my commute is not variable – the incidence of Caltrain blowups is far less than bad traffic.

    However – most people don’t have it so easy… but I don’t feel sorry for them. We all have choices in life…

  8. Capricious Commuter Says:

    Murphs, you mentioned the C-word. Two demerits. You can read it, just don’t mention it here ;-)

    As for your inflation-adjustments, Michael, I also remember seeing something like that and being slightly surprised. I agree that gas is much cheaper here than it is in most of the rest of the world, but I’ve gotta know, where is gas $7 a gallon?

    I lived for three years in Israel, which, despite being in the Middle East, has to import its gas from Europe and pay European prices, which came to around 4.5 shekels per liter, or $4.25 a gallon. Clearly taxes have a big impact on gas prices and can be used to drive them up artificially, but I can’t think of a government that would do that and risk alienating large swaths of the population. Ok, maybe one for the alienating part, but not for raising gas taxes.

  9. Frequent Amtrak Rider Says:

    As people drive less, the price will stay high, yes? Unless we have gas wars. Is the market set up so that one can have gas wars these days? I drive less but I don’t drive a lot anyway. I commute by BART and go to and from the station by car. I do most of my driving on the weekend. I can go on a half tank of gas for nearly two weeks and my car doesn’t get the best mileage.

    Speaking of hybrids, what happens to all those hybrid batteries when they die out? And now that eveyone is thinking about flourescent lighting, how do you get people not to dump them in the garbage and not contaminate the ground with mercury? Has anyone done an analysis on these tradeoffs to determine how they balance out? I’m not quibbling over the short term benefit but are there long term negatives to these changes?

  10. Michael Krueger Says:

    Where is gas $7 a gallon? Amsterdam. Other countries in Europe and Asia may not be as pricey as the Netherlands, but they are all significantly higher than what we pay here, and it has been that way for decades.

    As for the inflation adjustment, you are not the only one to greet such figures with suspicion. Many people view inflation adjustment as some kind of esoteric calculation only of interest to economists, but this is a huge impediment to popular understanding.

    I once read an economic analogy that has stuck with me: Money is like a ruler whose length changes a little bit from day to day. You could get by just fine using a ruler like this, as long as you’re comparing measurements made within a week, a month, or maybe even a year. However, if you imagine trying to compare a measurement you made today, with the short ruler, to a measurement made ten years ago, when the ruler was much longer, the comparison is meaningless.

    To make meaningful length comparisons when the length of your ruler is constantly changing, you need to have a method of tracking and compensating for the variations. Every so often, you could measure a variety of objects whose length you know is more or less constant, like the length of a certain stone in the garden, then record the reading shown by the ruler. Then you could use these readings to compensate for measurements of things that are not constant, like the height of a growing child. Factoring out the changes in the ruler would show you the true growth of the child over the years, which would otherwise be distorted by the variations in the ruler.

    It turns out that this is exactly how inflation adjustment works. The dollar is like a ruler whose length varies slowly over time. As any elderly relative can tell you, a dollar in 2007 doesn’t buy what it did in 1967, 1957, 1947, or 1937. It certainly doesn’t buy what it did in 1907, 1857, or 1807! To compensate for this, economists look at the history of prices for certain goods and services whose value hasn’t changed much over time and use this data to calculate an inflation-adjusted value of the dollar for any given year. This is just like measuring relatively unchangeable things like stones with the variable-length ruler in order to calculate the actual growth of a child over the years.

    So, to return to the topic at hand, you should be highly suspicious of any argument about long-term price trends that does not attempt to take inflation into account! Even a crude attempt at inflation correction is better than no correction, which is guaranteed to be deceptive.

  11. Inside Bay Area > The Capricious Commuter > market forces not just gas, eh? Says:

    [...] of you doubted me when I said in April we had reached the elasticity conversion point when it came to gas prices, i.e., the point at which high prices make us consume less in spite of [...]

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