Elasticity and Gasoline Prices
Martin Feldstein gives his take on rising oil and commodity prices in this story here. A large part of his story involves the concept of price elasticity of demand (and supply). Both food and gasoline have very low price elasticities of demand in the short run as consumers find it difficult to substitute away from these products. Read his entire (short) article for the rest of the story (and then go impress your family and friends with you new knowledge of commodity markets).
Greg Mankiw has been keeping track of news reports that illustrate how consumers are reacting to higher gasoline prices here and here. He entitles his blog posts "Cross-Price Elasticity."
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People are having a hard time understanding the current rise in the price of gasoline at the pump. The common error is to blame the ongoing war, the Hurricane that ravaged the Gulf coast, or the current economic “crisis”. These variables might have affected the current supply of oil and gasoline, causing the price to increase temporarily, but the actual reason that the long term price of oil and gasoline has increased is the concept of price elasticity of supply and demand. Gasoline has very low price elasticity. Gasoline prices would have to increase by a large amount in order to affect the level of consumption. The increase in price of oil and gasoline will affect other markets and people that are dependent on it for transportation of their products, the operation of equipment, and other vital parts of people and companies’ daily operations. This makes the demand for gasoline hard to decrease. The price of gasoline would have to increase by a substantial amount in order to decrease the global demand to balance with the current price of gasoline and oil.
Martin Feldstein’s article explains that owners of oil will not sell their product if the price is rising faster than the amount of money that they would make with the profits in the bank earning interest. An expected increase in demand for gasoline will cause the current price increase to stay the same. An expected decrease in the demand will cause the price of gasoline to go down. The oil owners would stand to make more profits buy producing and selling the oil, and investing the money so the supply of oil would increase.
The bright side to the elasticity of supply and demand for the consumer is; any policy or circumstances that cause the expected consumption of oil to decrease or the future supply to increase would lead to the price of gasoline to go down today. One of the negative attributes for the consumer is that the media or consumer reports of increased consumption or decreased supply of oil could make the price of oil to increase steadily. The solution for the consumer is to decrease global dependency on oil an increase the oil supply. Perhaps if Wall Street and the world market places were more profitable to invest the oil owners would liquidate more of their product, or if the global consumption decreased than it would become a consumers’ market.
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