## Study Identifies Structural Change in US Consumer Demand for Gasoline; Implications for Policies

##### 18 June 2007
 The two periods of the study experienced comparable changes in the price of gasoline. Click to enlarge.

A study by researchers from the University of California Energy Institute completed last year concludes that there has been a structural change in consumer demand for gasoline, with consumers appearing significantly less responsive to gasoline price increases now than 25 years ago.

Because of that change, they suggest, technologies and policies—such as CAFE—for improving vehicle fuel economy may be increasingly important in reducing US gasoline consumption, rather than reliance on market-driven price increases or the application of a fuel tax.

The study, by Jonathan Hughes, Christopher Knittel and Dan Sperling, estimated and compared the short-run price elasticities of gasoline demand in two periods of comparable price volatility: November 1975 through November 1980 and March 2001 through March 2006.

The results presented here strongly support the existence of a structural change in the demand for gasoline. Estimates of the short-run price elasticity of gasoline demand for the period from 1975 to 1980 range from -0.21 and -0.34 and are consistent with estimates from the literature that use comparable data. However, estimates of the price elasticity for the more recent period are significantly more inelastic ranging from -0.034 to -0.077. This result has important policy implications.

The short-run price elasticity is a measure of the change in demand—either through a reduction in vehicle miles travelled, an increase in the fuel efficiency of driving (e.g., through better maintenance, more efficiency-oriented driving behavior) or both. Although short-run elasticity may also include responses such as the purchase of more fuel-efficient vehicles, the researchers note, vehicle purchase decisions are typically more long-run in nature.

There could be multiple explanations for the change, they suggest, which may reflect shifts in land-use, social or vehicle characteristics during the past several decades.

Whatever the cause, the results presented here suggest that today’s consumers have not significantly altered their driving behavior in response to higher gasoline prices. It is important to note that these results measure consumers’ reactions to short run changes in gasoline prices. However, it is the long-run response that is the most important in determining which polices are most appropriate for reducing gasoline consumption.

They conclude that reduced responsiveness in adjusting miles driven to increases in gasoline price is unlikely to change significantly for long-run behavior because the factors that may contribute to inelastic short-run price elasticities such as land use, employment patterns and transit infrastructure typically evolve on timescales greater than those considered in long-run decisions.

In terms of vehicle fuel economy, consumers may respond to higher gasoline prices in the long-run by purchasing more fuel efficient vehicles. However, if consumers in the period from 2001 to 2006 were purchasing more fuel efficient vehicles in response to higher gasoline prices, one would expect to see at least a portion of this effect in the short-run elasticity.

While our results do not preclude a significant shift to more fuel efficient vehicles in the long-run response, the highly inelastic values that we observe suggest that the vehicle fuel economy component is small. If the long-run price elasticity is in fact more inelastic than in previous decades, smaller reductions in gasoline consumption will occur for any given gasoline tax level.

As a result, a tax would need to be significantly larger today in order to achieve an equivalent reduction in gasoline consumption. In the U.S., gasoline taxes have been politically difficult to implement. Higher required tax levels pose an addition hurdle. This may make tax policies impossible to implement in practice. In this case, alternate measures such as increases in the CAFE standard may be required to achieve desired reductions in gasoline consumption.

(A hat-tip to Bob!)

Resources:

They need to raise the tax on gasoline 1 penny per month forever (not my idea). Take the money and subsidize the price of hybrids and public transportation. This country needs high speed rail like they have in Europe. People are spending too much of their lives stuck in traffic.

I think it matters a lot if the public perception is that the prices are temporary or if they are permanent. If the changes are perceived to be temporary, then folks will just figure that they need to suck it up for a few months, and then life goes back to normal. That was the thinking after Katrina, for example...

The runup in prices this summer seems to have caught the general public by surprise however.

I'm tired of hearing how people aren't responding to price increases. That's because the increases have been insignificant, the government is giving it away (through subsidies). Always has been. Bring gasoline to its true (environmental, health, social and military) cost of $8.00 to$14.00 per gallon and just watch them respond.

Also, real incomes have risen since the '70s and energy costs are now a less significant portion of consumer budgets than ever before.

Americans respond with whining and conspiracy theories whenever the price of gas goes up. People act like it is their constitutional right as an American to have cheap gas. Then they wonder how we end up in an hellhole like Iraq.

One of the reasons people complain about gas prices but don't actually change their behavior is that fuel cost actually represents a smaller share of disposable income today than it did 30 years ago. Also, people back then still remembered the gas lines of 1973, with a second supply shock in 1980. It shouldn't surprise anyone that most consumers aren't doing more than complaining.

What matters strategically is lasting structural change in traffic patterns, vehicle technology and fuel technology. This includes intermittent grid connectivity for PHEVs and BEVs.

Weaning an entire nation off its love affair for gas guzzlers is project that will take 10-15 years minimum for the vehicle fleet and 20-30 years minimum for the urban and traffic planning aspects. Even then, success will only be partial because some past mistakes are all but irreversible.

Getting to grips with the decline of crude oil - hastened by the rapid emergence of China, India and Russia - is the primary global challenge of the first half of the 21st century. If we should fail, there will be another world war. Islamist terrorism - frightening though it is - is actually merely a nuisance by comparison.

As usual Raph, nicely put!

What has happened is simple.

Due to 9/11 alot of people swiched perminently to driving. They set thier 10 yearadgenda and wont change till some time down the road.

They just cut elsewhere and thus as costs go up other things get chopped... but they still vacation they still travel.

But we all are peering at the future and plotting our next move.

BUT the next 10 years are far to chaoticto plot out. So we wait for the future car... we wait for grandma to die so we can stop driving 3500 miles every xmas.. we wait to see just what the hell pops up.

Rafael- You are correct on all points.

BlackSun- Whereas I agree that higher fuel prices may alter "some" driving habits, at $14.00 a gallon, inflation would soar, our economy would collapse, and all that "tax" money would be used on social walefare programs. Joe Rocker- It would scare the hell out of me to know that our government would have all that tax money at their disposal. Like Social security, the money would be thrown into the general fund and spent on "earmarks," which is actually pork by another name. What I'm trying to say is, why is it acceptable for our politicians to raise taxes on fuel to the excess, but a legitimate business is crucified when they raise prices. Besides, once a tax always a tax. There must be a middle ground to allow commerce to flourish, while at the same time, allowing alternate energy and more fuel effecient vehicles to be developed. Meanwhile, my wife and I, while keeping the same vehicles, have reduced our miles traveled per year by 40%--the equivalent of my paying$1.50 per gallon, all things considered. It ain't easy, but doable.

shigley,

I'm not saying implement something like that all at once. But there was a time not too long ago when people thought $4.00/gallon would be disastrous to the economy. Now they shrug and don't change their habits substantially. If petro-gas was allowed to rise closer to its true-price, then battery EV's and other promising technologies would suddenly take center stage as a cost-effective solution. Far from decimating the economy, such a transition will breathe new life into it. People would wonder how they drove such inefficient and impractical vehicles for so long. Unfortunately, we do not have a free-market in this area. If we did, the transition would have happened long ago. If advertising is any indication, consumers are finally paying more attention to questions of fuel economy -- they are regarding high fuel prices as a long term situation, and auto marketers, at least, think that they will begin to act on that in their purchasing decisions. I think the authors made a mistake of logic when they asserted that car-purchasing choices should show up in the short-term elasticity data. The other posters are right, I think -- if you regard a fuel price spike as temporary, you'll buy the car you always wanted anyway, even if making the purchase in the middle of the spike, and buy gas out of savings until things return to normal. Only when people realize (explicitly or implicitly) that things are long term to the begin to act that way. When thinking about purchasing decisions, though, one must realize that a dollar is fungible. If gas prices go up long term, fuel economy does not have to go up in equal proportion in order for a person's transportation budget to balance. A consumer could forego some options, choose a cheaper model, or retain a car for a slightly longer period before trading-in, all in an effort to lower the monthly payment. The extra money then goes to pay for the more expensive gas, and life goes on as before. Some of those cost cutting choices (foregoing the larger engine option, choosing a smaller / cheaper car) can lead to increased fuel economy; some won't. The that higher gas prices become, the more the pressure to cut costs (if all things -- namely miles driven -- remain the same), and the more useful an mileage-maximizing choice becomes as well. From the "green" point of view, we must ask as to the value of all these various choices, and not just the fuel economy factor. Holding onto cars longer means that for a given fleet size, fewer replacement cars must be brought into service every year. That saves resources on the manufacturing side, even if it doesn't save gas on the fuel economy side. Similar considerations apply to buying smaller cars and smaller engines, even before you start measuring the fuel economy gains thereby achieved. To me, direct regulation should be something of a last resort. We mandate catalytic converters because there is no other way to prevent the release of noxious pollutants. Regarding greenhouse gases, we have yet to show that externalities-taxation and price signalling would not be reasonably effective at reducing their emission at *some* point along the line (at the manufacturing stage if not the fuel economy stage, etc.), or at least providing resources to subsidize enough mitigation measures. I say try a broad carbon tax first, before mandating this that and the other specific thing. This study of the short term price elasticities of one particular carbon product tells us virtually nothing about the big question -- though it is useful to the oil companies, who now know that they can spike the public at will from time to time, as long as they reduce prices in time for us to remain under the impression that spikes are temporary. I say this not as a conspiracy theorist, but as someone who has read the newspapers -- the concentration of refinery assets in the hands of a few major oil companies, after the last wave of mergers, is suspected of creating monopolist power in the industry, even if no actual collusion can be demonstrated. There is a reason we broke up Standard Oil a long time ago, and it is faintly ironic that we have allowed the pieces to re-assemble themselves over the years into such large conglomerates. Why would people change their behavior when there are few available alternatives. People will be stuck in traffic as long as roads and airplanes are the only alternatives. Plug-ins won't change that. People are not in a hurry to buy small cars when they are surrounded by huge SUV's. You may tell them they are safe, but they don't feel safe. I would ride my bike more if there were safe bike paths, and there are some -- but not enough to get me where I have to go every day. Structure drives behavior as much at least as much as economics. If you want the Government to do something, forget incentives and regulation. Leave those to the marketplace. Instead offer PRT, dedicated bike paths, fewer and Lexus Lanes. The price of gas means little when compared to the price of time. It does make you wonder what the price of gas would have to get to before there's a real effect. Would it have to go to$5/gal or $7/gal before we really saw some changes in peoples driving habits and buying habits? Being old enough to remember the last time gas hit its peak (adjusted for inflation), I was expecting a bigger impact from the price runup of this summer - but it mostly seems like people have shrugged it off. Considering that hybrids now represent about 3% of the new vehicle market, there is already a substantial effect being felt in the marketplace at$3 a gallon. I'd like to see inexpensive micro- and mild-hybrid tech deployed across entire product lines. Boosting a 15mpg full-sized SUV to 18-20 MPG city and 25 HWY represents a significant fuel savings.

I don't know enough of the study to judge its analytic soundness, but as others have noted, it shouldn't be too surprising we're at a relatively inelastic point on the curve given wage growth.

Philosophically, I have something wrong with CAFE standards. I'm not sure why a company has to achieve any sort of fleet average--it surpresses specialization and benefits anyone who happens to cater to more efficient cars. The best large SUV manufacturer in the world may be in the wings ready to start up, but they would need to find a way to bring their average down, thus preventing their entrance. Production mandates reduce choices to the consumers, with little to no public safety benefit.

I think it much better to tax petro-gasoline and inefficient cars at the outset to cover their externalities and link those revenues to a cut in income taxes at the bottom of the range (ie so everyone benefits at the same rate). This will require some additional EITC (earned income tax credit) adjustments and other policy tweaks to compensate those unemployed (like students), but this is the best way to switch our tax burden to an undesired behavior and away from a desired one (gainful employment). I'm not for increase gov't revenues--this would be revenue neutral at first and then decline overtime as gasoline consumption declined.

NBK and others point out the study tells us something about elasticity in the short run. And it means little.

People complain about gasoline prices because they see them often and notice they change quickly for little apparent reason.

If you spent $60 for paper plates for a barbeque every week and that jumped to$80, fell to $65, and rose to$85 you would scream. But if the price settled at $85 you would shut up after a couple of weeks. Watch the sales trends of hybrids and the offerings of vehicle makers - EV, HEV, PHEV, diesel. No one has to produce them and no one has to buy. One reason short term elasticity is so bad is that vehicles last a long time. And that has probably doubled since 1970. As gas prices rise the price of gas guzzlers falls making makes them a good buy for low mileage drivers. Both factors keep short term elasticity low. Most posters in this forum make more sense than this article. It is impossible for the public to respond to gas price hike in the short term. Therefore, it is very important for the government to have the foresight to: 1) institute a gradually increasing CAFE standard, 2) to guarantee a gradual increase in gas price via compensatory taxation of gasoline, depending on the market price. If the gas price increases by itself, then there is no need to raise gasoline tax. But, if gas price should decrease, then the government should step in to raise the fuel tax enough to maintain the gasoline price at a guaranteed level. This should be well publicized so that everyone will be able to plan for fuel conservation by buying fuel-efficient vehicles and by living closer to work place. This should cause no undue hardship to the public in the short term, and will save the country and our auto industry from a major catastrophe of fuel shortage in the future. I should hasten to add to the above: 3) Hold taxation of renewable fuels such as biodiesel, hydrogen, cellulosic ethanol etc. such that these renewable fuels, in time, with a predictable rise in fossil fuel prices, will become competitive in a precise time table that would allow consistent investment years in advance. Together, all these 3 steps will allow for a smooth transition to a renewable fuel economy. Since the energy companies such that oil and gas will likely increase their investment in renewable fuels to avoid fuel taxes, they will less likely to lobby congress to maintain the status quo, that is, if the current Congress has enough balls and wherewithal to institute plans 1) and 2) that surely will be opposed by Big Oil in the near term, because that will reduce their potentially enormous profit when gasoline will run scarce. Actually, the graduality of the gas price increase will ensure that Big Oil will still make enormous profit in the near term. Big Oil will still have to invest in renewable fuels eventually, because oil won't last for much longer. I'm opposed to any additional taxes on gasoline, because they never go away. Example: In 1889, a 3% excise tax was leveled on the telephone to fund the Spanish-American War. So far, as of July 2005, approximately$300 billion dollars was collected for a war that cost $6 billion and, was won in 6 mos. The IRS lost seven court cases when the tax was challenged and still the persisted. Example: The alternative minimum tax, introduced as a "tax reform initiative," was originally levied in 1970 to tax those individuals that paid little or no income tax. (the rich or near rich who had lots of deductions) But--it was not indexed to inflation, etc. And now, one in five tax payers are affected. Congress is studying the "situation." Yeah, sure. One more example then I'll shut up: The New York State Thruway was build as a toll road to pay for the construction. (about ten years) Four decades+ later it's still a toll road. Sorry for rambling but it really burns my grits to think of another never ending tax. I would much rather see the free market dictate energy prices, even if it means more profits for big oil. After all, millions of stockholders own them, lock stock and barrel, myself included. And I'm sure a few of you have oil stocks somewhere in your portfolio. You forget one virtue of gas taxes, shigley: they disappear when the gasoline does! Shigley, Since a gas tax, by design, is not meant to go away any time soon, there should at least be no worries about a bait-and-switch of the sort you complained about before. After all, the government will always need taxes of some sort or another. Collecting them at the pump as opposed to out of our paychecks at least presents us with the opportunity to price some important externalities into a widely consumed commodity. Collecting them at the tollbooth, by the way, is also probably a good idea for the same reasons. The Thruway costs money to maintain. Users of the freeway cause wear and tear, contributing to the maintenance costs, in ways that non-users don't. That road is also, frequently enough, space constrained. After a certain point, every extra car materially contributes to the slowing, through congestion, of the cars around it. Pricing in that externality is presumptively a good thing. (I'd support different tolls for different times of day, or different stretches of road, depending on the prevalence of congestion, by the way, in case someone would propose it.) And taxes don't always go up. I can point to the tax overhaul of 1986, and the recent Bush tax cuts, as examples of movement in the opposite direction. That, and the fact that the Alternative Minimum Tax has frequently been adjusted by Congress to keep up with inflation, and such fixes will likely continue into the future. A general distaste for taxes, and some Spanish-American war anecdotes, are not really enough to convince me that a well calibrated gas tax is a bad idea. Living closer to work is not a choice everyone has. Lets say houses "close" to work are$500,000 or more and houses "far" from work are $250,000 Lets say a morgage is 30 yrs.$250,000 is alot of gasoline.

@ $3 per gallon (to make the math less messy) that is 83 thousand gallons. Even at 20 mpg that is enough to drive 1.6 MILLION miles so as long as the cheaper house is not more than 100 miles or so farther away than the "close" house you come out ahead. Not to mention that for many the more expensive house is not an option in the first place. Plus if you end up working for a different company or for at a different location then the advantage of the closer house could be lost. Governments at all levels need taxes, and I'm not opposed to that. I am, however, against taxes for the purpose of social engineering. I still believe in free enterprise. Oh, sure, the government, like someone suggested, can come up with some convoluted tax scheme for the lower income to offset higher fuel taxes, but what about small business', tradesmen, farmers, and many others who must use larger, less fuel efficient vehicles for their livelihood? You can't simply paint everyone with the same brush and expect a level playing field. Oil company profits are around 10%, and yet they are demonized for excess profits and conspiracy theories, which, by the way, has never been documented in any administration, be it Demorcrat or Republican. On the other hand, the combined federal and state taxes on a gallon of gasoline in NYS is around 22%, figuring a$3.00 price per gallon. Footnote: Pharamacuticals & medicine (another "must have" commodity) profits are around 21%, whereas in the seven major business catagories, oil companies are next to last in profits. Having said that, I firmly believe that any oil company subsidies should be rescinded posthaste and use the monies for alternate energy research.

The monies collected on the NYS Thruway, by and large, goes into a black hole called the "general fund." A la, Social Security, no?

I firmly believe that gasoline taxes should be used exclusively for road construction and maintenance, whatever the cost.

To my knowledge, the Alternative Minimum tax has never been adjusted for inflation, and that's the problem. Congress would like to find a solution but they don't want to give up the billions of revenue dollars.

And finally, I doubt that we will see the demise of gasoline in our lifetime. We can only hope that the consumption will be reduced considerably within the next decade.

Shigley,
A couple points. The 10% profit measure on oil companies (vs. the 21% on pharma) is the wrong measure, and not surprisingly is being touted by Big Oil as a distraction. It doesn't matter how much profit you make on every dollar of sales (furniture stores make $0.50+ versus$.04 for Costco for example), what matters is how much you make on investments, i.e. I plugged down $1MM in investment and am now making$1MM a year in profit. On that basis, the oil companies are living large (Exxon has return on assets of 19.4% and return on equity of 35.6%, while Merck is 12.3% ROA and 24.8% ROE, as a comparison of industry leaders). Imagine making 35.6% on your equity for 4-5 years--you'd be sitting pretty.

The thing with farmers and other energy intensive industries is that they would need to change their business models, gradually, and with some assistance from congress (as if they need anymore). They operate the way they do b/c fuel is unrealistically cheap.

And, as someone else noted, the gasoline tax declines as consumption declines. If you want to pay less tax to the government, buy a more fuel efficient vehicle. It's that simple. How's that for a smart way to reduce the tax burden. Likewise, if you're addicted to Hummers, by all means, pay your excessive consumption tax at purchase and enjoy your \$200 tank fills. That way my son and daughter will not be fighting in Iraq, Iran, Nigeria, Angola, or Sudan in 20 years.

By the way, one last point. I wouldn't care at all if all we were talking about were oil company profits. We're not. We're funding both sides of a war, and preventing autocracies from modernizing with the flow of our dollars. Big difference.

And sure, like you, I'm invested in oil companies.

Of coures the oil companies, like all compainies, take advantage of market forces and intelligent investments. Wouldn't you, if you were in business? If the powers that be didn't maximize their profit opportunities, how long do you think they would last?
Farmers were mentioned, and they are subsidized. Point taked. But there was no mention of the tradesmen, etc. They certainly aren't subsidized, and the only thing they can write off is vehicle deprecation or business miles traveled.

There was never a doubt in my mind that we went to war in the Middle-East, in large part, because of oil. Without oil, the entire world economy would collapse. The intention, I suspect, was to get in, win the war, and get out. Big mistake, because it didn't happen. Unfortunately we can't un-ring the bell. What is is what is.
Do certain business' take advantage of the situation? You bet! From the wellhead to the futures market on Wall Street, to the corner service station. Once alternative fuels are fully integrated into our society, maybe ADM will be the next Exxon-Mobile, then we can blame them for high energy cost.

I'm not a big fan of Hummers. In fact, I think they are ridiculous. My choice would be a Prius or a Camry, which I plan to buy in 2008, but, again, I am not in business so I don't need a large utility vehicle. Some do.

I for one would prefer to never buy another gallon of gasoline and, like most everyone, wish the energy crisis was behind me, but it isn't, and won't be for some time to come. As I see it, we are on two energy tracks. One is fossil fuels that the world must weather for the forseeable future, and the other is the transition to alternative fuels that are in the pipeline. In the meantime, there are no easy answers, but to pit one segment of society against another, one industry against another, or to see collusion and conspiracies around every corner is simply not healthy for any society.
I'm probably way off point here, but it really aggrivates me to hear someone say the everyone should move closer to work, ride bycycles, or drive a puddle-jumper. If that fits their lifestyle, fine, and I commend them. But you simply can't put everyone in the same box.

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