Understanding Inelasticity of Transportation Demand
Last week, the Bureau of Labor Statistics released its latest numbers on consumer spending for 2013. Drawing from the updated figures, we did a write-up of the burden of gas prices on American households, particularly its lowest earners. Overall, 5 percent of U.S. household spending is dedicated to gasoline, with that figure approaching 12 percent for the lowest-earning quintile. However, it seemed worthwhile to examine if there was evidence within the Consumer Expenditure Survey to see if one of the most common assumptions about the impact of gas prices on the economy is true: do gas prices have a noticeable impact on discretionary spending? Or in other words, when gas prices increase, does spending on other discretionary items fall accordingly? After all, gasoline demand is understood by economists to be highly inelastic, despite its relatively volatile price compared to other basic necessities. Research from the University of California at Davis summarized the recent research, stating, “The literature shows increasingly inelastic demand for gasoline with respect to price in both the short and long run and recent studies have shown that short-run price elasticity of demand has decreased in absolute value by up to an order of magnitude in the past decade, meaning that consumers have become significantly less responsive to changes in gasoline price.” The reason that gasoline demand is relatively inelastic is intuitive. Outside of certain parameters, most of people’s driving is essential: They are commuting to and from work, getting their kids from school, running errands, etc. Economists report that consumers respond to high gas prices in two ways—first, by either driving less (which, as just mentioned, will only get you so far), or second, by driving more fuel efficient vehicles. While this might change the demand outlook in the longer term, most people don’t run to the car dealership to buy a Prius as soon as they see gas prices climb. When an oil crisis hits, the nation must cope with the automotive fleet it has, not the one it wants. So when gas prices rise, it is often reported that consumers must cut back on their discretionary spending, on things like clothes, restaurants, and entertainment. Arguably, this impact is clear enough that it can be seen in BLS’s data. The data is somewhat blunt, providing national and annual averages. However, compiling spending on clothes, restaurants, and entertainment shows that in the past decade it has typically moved in the opposite direction as gasoline spending—reinforcing the idea that high gas costs have cut into these sectors.