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.

In 2002, 2003, 2004, 2006, 2007, 2010, and 2011, changes in spending (as a portion of total expenditures) moved in opposite directions for gasoline versus discretionary spending. In 2002, spending on gasoline fell, and spending on discretionary items rose. In the other years, households spent more on gasoline and cut back on clothes, restaurants, and entertainment. In 2009 and 2009, spending on both gasoline and discretionary goods moved in the same direction, but of course, some abnormalities can be expected during the recession. 2005 and 2009 did not follow the general trend, with spending on both categories moving in the same direction, and in 2013 spending on both remained relatively flat. The fact that discretionary spending and gasoline spending has moved in opposite direction is also evident in the following chart. Discretionary spending as a percentage of total expenditures has fallen by roughly two percent, while gasoline spending has increased by about the same.

Furthermore, in absolute terms (rather than relative, as a percentage of total spending) we can see that household spending on gasoline has nearly doubled since 2001, while the other criteria have remained flat or declined. Keep in mind, this chart does not account for increases in income and expenditures during the past decade, so while the amount of money spent on things like entertainment may have remained relatively flat in numeric terms, they have actually fallen as a percentage of total spending. That is not to say that correlation equals causation. These charts are a rough analysis based on national averages. Furthermore, only three categories of “discretionary” spending are included, and it’s hard to tell what other choices American families have made due to the increase in gas prices in recent years. For example, they may have chosen to move closer to their jobs to shorten their commute, or given up a certain number of weekend road trips. Needless to say, the increase in burden from 2-3 percent of total spending to over 5 percent is disheartening.