[econoclectic] EclectEcon: Oil Companies Cannot Just Pass the Increase on to ConsumersExpectations and Elasticities

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Posted by EclectEcon:
Oil Companies Cannot Just Pass the Increase on to ConsumersExpectations and Elasticities
http://econoclectic.powerblogs.com/posts/1213873101.shtml


   When crude oil prices rise, gasoline prices rise, too. But not all the
   cost increase can be passed on to consumers. At least not without
   affecting the quantity of gasoline that people buy.
     * When prices rise, the quantity demanded falls. Demand curves are
       downward-sloping. This is the "law of demand".
     * People respond to incentives.

   My point is that gasoline is not a necessity. When it becomes more
   costly to use gasoline, people find substitutes, and they actually
   tend to do so fairly quickly.
     * They buy smaller cars.
     * If they have two cars, they begin to use the smaller car more
       often.
     * They bicycle more.
     * They walk more.
     * They make greater use of public transportation.
     * They take fewer trips.
     * They make shorter trips.
     * They move closer to work or closer to public transportation
       connections.

   And all these things that economists have been saying for decades have
   been confirmed. From the [1]USA Today,

     Americans drove 30 billion fewer miles from November through April
     than during the same period in 2006-07, the biggest such drop since
     the Iranian revolution led to gasoline supply shortages in 1979-80.
     The numbers released Wednesday may reflect more than a temporary
     attitude change in consumers toward high gas prices, Transportation
     Secretary Mary Peters said. Previously, she said, "people might
     change their pattern for a short period of time, but it almost
     always bounced back very quickly. We're not seeing that now."
     ... "It's not a blip," said Marilyn Brown, professor of energy
     policy at Georgia Tech, citing data showing surging transit
     ridership, dropping sales of sport-utility vehicles and sharply
     increased demand for gas-efficient vehicles. "I think the
     difference between now and 1979, when prices were comparable when
     you adjust for inflation, is there's a sense of sustained pain.
     There's a sense that the era of cheap energy is a thing of the
     past."

   Clearly an important determinant of the price elasticity of demand for
   gasoline is the expectation that people have about future prices. If
   rising prices create an expectation that prices will soon fall back to
   their previous levels, and if it is costly to change consumption
   patterns, then the price elasticity of demand will be quite low. But
   if rising prices create an expectation that prices will remain higher
   and will likely even rise some more, then people will begin to
   undertake the costly changes in their consumption patterns.
   After Katrina, gasoline prices were about as high where I live as they
   are now. But back then, we all expected the high prices were a
   temporary blip, and so we did not alter our consumption patterns very
   much. But this time, when people expect gasoline prices to remain
   high, people are changing their consumption patterns.

References

   1. http://www.usatoday.com/printedition/news/20080619/1a_lede19_dom.art.htm