Is it $4.11?
Although gasoline prices are rising, consumers have not altered their driving habits. Economist James Hamilton suggests that the tipping point tends to be when prices exceed the highest point during the past 3 years. That number is $4.11 or $4.27 if we account for inflation.
Currently, the average price per gallon of regular in the U.S. is $3.72 while Wyoming has the cheapest gas at $3.16 and California has the most expensive at $4.33.
Looking beyond our borders, though, $4.33 can seem pretty low. For these countries, fuel taxes elevated prices. (March 2011 data)
- U.S.: $3.59
- Istanbul, Turkey: $9.63
- Oslo, Norway: $9.27
- Athens, Greece: $8.50
- Amsterdam, Netherlands: $8.01
On the other hand, subsidies can make the price per gallon of gasoline pretty low:
- Caracas, Venezuela: $.06
- Riyadh, Saudi Arabia: $.45
- Doha, Qatar, $.88
For 170 countries, these graphs are ideal except that the data is for 2010.
Finally, where are we historically? Going way back to 1919 when the price of gas was close to 25 cents–the equivalent today of $3.35–this graph provides a fascinating picture of where gas prices have been. At all time highs now, real prices were slightly lower when they peaked during 1981 and 2008.
The Economic Lesson
Observing the impact of gasoline price swings on consumer purchases, economists cite our elasticity. If price changes a lot and the quantity we buy remains almost the same, as with medication, then our demand is inelastic. By contrast, if price changes have a big impact on buying, then our response is elastic.
An Economic Question: If, at $4.11 per gallon, we start to buy a lot less gasoline, then how might you use elasticity to describe the change in our buying decisions?
How have we responded to higher gas prices?
According to a recent study, our first response is to buy a lower grade of gasoline. Drivers, used to premium, opted for regular gasoline instead. However, because we have different “budget baskets,” we do not initially cut our clothing purchases or what we spend on food.
We respond also by looking for lower priced gas. Using GasBuddy.com as one source of data, an Ohio State economist observed that traffic soared on the website when prices skyrocketed during 2008. When prices fell, traffic subsided. (This website lets you compute how far you can drive before the mileage offsets the savings.)
And finally, higher gas prices affect how we respond to falling prices. We tend to select a “reference price”–an amount we associate with an item. For gas, if the reference price is the elevated amount, when price starts to fall, we do not shop around as much. Seeing less pressure to lower their prices, sellers delay. As a result, gas prices rise much faster than they fall.
You can look here for more about higher gas prices.
The Economic Lesson
The “fast rise/slow fall” phenomenon for gas prices happens wherever competition is minimal. If retailers can price gasoline similarly, they are behaving like an oligopoly with some pricing power.
An Economic Question: Imagine a competition scale or continuum. To the left is perfect competition with many small firms, identical products, and no pricing power. The market controls their behavior. At the other end is monopoly where the firm has considerable pricing power, is large, and has no competition. Where would you place gasoline retailers? Why?
Our story begins during February when Russian Prime Minister Putin decided to freeze gasoline prices. Oil companies had a predictable response.
Following the money, they redirected their supply to higher prices elsewhere. The result? Russian gasoline exports were 40% higher than last year at the same time.
A second result? The Russians (almost) ran dry.
So now, the Prime Minister is banning exports during May for “high octane petrol sold at the highest prices.” Also, he is upping export duties and cutting local sales taxes.
The Economic Lesson
Demand and supply graphs continue the story. With price our Y-axis and quantity the X-axis, draw an “X” as the lines on your graph. The downward sloping line is demand and the upward sloping line is supply. Next draw a horizontal line below equilibrium, the point where the demand and supply lines meet. This line, called a ceiling (because it stops prices from rising), illustrates why we get a shortage. The distance between the point that the ceiling crosses supply and the point that the ceiling crosses demand represents the size of the shortage. A shortage is precisely what Mr. Putin created.
Now with export taxes, he is making supply more expensive. Then, typically, the supply curve shifts to the left and upward. And producers decide to supply less.
An Economic Question: The Prime Minister’s goal is to make consumers happy. Will he be successful? Hint: Think about price and quantity.
A government decision to stop subsidizing gasoline prices in India fueled protests last week. The subsidy cost the indian government 2.5% of its budget ($5.5 billion). Now, with prices responding to the market, the record high deficit can drop. However, a liter at the pump will increase by 3.5 rupees or 8 cents (6.7%)–the equivalent of almost 30 cents a gallon. Protesters also claim that expensive gas will send the Indian inflation rate beyond a 10% rate.
Events in India took me to gasbuddy to see where the price of gasoline has been in the United States. A five year chart reveals that a gallon of unleaded regular averaged between $2.11 and $3.11 in 2005, touched $4.12 in July, 2008, and dropped to $1.61 soon after. Now, we are at about $2.70.
The Economic Lesson
When economists discuss gas prices, sooner or later the topic turns to elasticity. If price changes a lot and the quantity we buy remains relatively stable, then our price elasticity of demand is inelastic. By contrast, if price swings have an impact on buying, then our response is elastic. Economists believe that our demand for gas tends toward inelastic. Consequently, to encourage less fuel consumption, we could not depend on moderate price hikes at the pump. Instead we would need big price jumps, income drops, and more hybrids.
Posted by: adminEcon
Tags: elasticity, gasoline, India