(In) Elastic Gas

Here we go again with the gas prices. Although the reasons behind high gas prices are often complicated, there is a major cause that is always almost ignored when people talk about gas prices—elasticity.

We are all familiar with the concept of supply and demand. If a price goes up, then suppliers will supply more quantity and consumers will demand less. When prices fall, consumers will buy more, while suppliers cut back on production. Easy enough, but people often forget that, while price changes will cause buyers and sellers to alter their behavior, the question remains, “but by how much?” Economists measure “by how much” with a concept called elasticity. If a price change of a good causes people to alter their consumption or production behavior dramatically, then the good is said to be elastic. If the quantity supplied or demanded changes very little in response to a change in price, then the good is said to be inelastic. The problem with gasoline is that both its supply and demand are highly inelastic. As gas prices rise people complain a lot (I know I do), but we really do not cut back our consumption very much. The same is true with supply. With prices high, refiners would love to bring more gasoline to market, but they are running into capacity, maintenance, and regulatory roadblocks, so, at least for the immediate future, they can only squeeze so much gasoline out of their capacity—no matter what the price does.

Unfortunately, this leaves the consumer in a tight spot. The law of supply & demand dictates that the quantity demanded must equal the quantity supplied. Something has to give and that something is price. Since peoples’ gasoline consumption barely budges with rising prices, then prices have to rise considerably in order to bring the quantity supplied and demanded into equilibrium. To put it another way, if the U.S. wanted to halve its gasoline consumption, then it would not merely be a matter of doubling the price, but most likely quadrupling or quintupling already high gas prices. There is already a lot of talk about gas prices, and there is only going to be more. However, with all the hot air to be bellowed and ink spilt, there will likely be nary a mention of the “e” word.

Comments

[Kay Masters]

Thank you for putting into words what I have been trying to articulate for a long time.

When gas prices go up I look around and I don't see anyone walking to work, or riding the bus or their bicycles too much. So obviously we value gasoline very highly, even though we don't like to pay very much for it.