In the middle 1970s I did a short stint in the White House (my second) working with William Simon on the creation of the Federal Energy Office. One of the most important lessons I learned then was about the ultimate price responsiveness of the gasoline market. Within the office, which was several months of helter skelter activity, there was a fierce debate about whether the quick rise in prices (during the initial days of the Arab oil embargo gasoline prices grew by several fold - at a much higher rate than the recent rise from $3-4 per gallon) would dampen consumption in the short or long term.
Simon was a wonderful person to work with. Ed Feulner, the President of Heritage Foundation described Simon as "a mean, nasty, tough bond trader who took no BS from anyone." He was also quick to judge people. Luckily for me he thought I did pretty good work. He was in the office possibly an hour before most of his staff and often stayed later than many of us. He was a demanding boss. The debate about the elasticity of demand was pretty basic. With the jump in prices would consumption of gasoline drop? How much of a jump would cause how much of a drop?
Simon argued that gasoline was an almost infinitely responsive commodity - i.e. as prices rose, demand would dampen - people would drive less. I argued at the time that there was a lot less elasticity because there were some needs for driving that people would not give up. I was wrong. In this cycle SImon's initial thoughts have been reinforced. Through May of this year Americans drove 29.9 million fewer miles than they did a year ago. The May-May decline (2007-2008) was the largest in 66 years. Since December three of the largest month declines have happened since December. That reduction amounts to a bit under 4% - year to year.
Are there allocational effects (does the increase in price hurt people with lower resources more than upper income people)? Of course. But as Simon taught me more than 30 years ago - the market here is pretty responsive.
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1 comment:
I wouldn't say you were wrong. You didn't argue that prices were entirely inelastic. You argued that there were limits to elasticity. People can give up pleasure driving and road trips, but they still have to get to work and the grocery store.
You say people have driven 30 million miles less than last year. With 300 million people in the US, that means that on average each person has driven 1/10th of a mile less through may than they normally do. That doesn't scream elasticity to me... (although, people may be using more gas efficient ways to travel, which isn't included in this analysis).
I'm not so willing to give up on your original hypothesis as you are...
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