My Two Cents - "Inelastic or Relying on Plastic?"
5/4/2007
A few months ago during a conversation with a friend, I predicted that gas prices in the Northeast would be $2.75 per gallon for regular unleaded by Memorial Day. Here in Eastern Pennsylvania, we crossed the $2.75 during the Easter weekend. Right about this time, the same friend asked where I thought we'd be come Memorial Day. I shrugged my shoulders, pointed to the sky and said 'as long as there is a limit left on the credit cards, nothing will change'. Of course, I was probably being overly cynical and generalizing, but after further reflection realized that there was probably more than a small amount of truth in that unctuous utterance.
The demand for gasoline is fairly inelastic to price changes. Essentially this means that the change in demand will not be proportional to a change in price. For example, if the price doubles, we will not see demand cut in half. This notion is represented in the chart below where between $1/gallon and $2/gallon the demand dropped by a comparatively small amount:
For a long time, economists and market watchers have thought that somewhere around the $2.50 - $3/gallon mark we would cross a psychological Rubicon and begin to see demand destruction. People would change their behaviors, drive less, eliminate demand and along with it the upward pressure on prices. For approximately the past two years now, we have dealt with relatively higher gasoline prices and we have yet to see that demand destruction occur. In fact, demand is rising in the face of these high prices. Now I don't believe that people look at the price and say to themselves "I'm going to go drive more". But ostensibly, that is what is happening. While I am not a price watcher per se, I have heard that already, many areas have crossed the $3/gallon mark, and undoubtedly, many more will do so by the time the peak consumption period has passed.
One newsbit that immediately jumped out at me was the report on Ford's vehicle sales for the month of April. While the company's overall sales were down 13%, sales of the gas-guzzling Expedition and Navigator SUV's were up 27% and 13% respectively. WHAT?? Let me get this straight. We are already facing very high gas prices, and these prices seem to have nowhere to go but up and yet people are STILL buying these behemoth SUV's that at best get 15 miles per gallon? We have discussed on prior occasions the consumerist entitlement mentality that the majority of America seems to have acquired in the 21st century and these numbers do nothing to dispel that belief. As far as I am concerned, Ford could be giving away those money-pits disguised as cars and I wouldn't be interested. Certainly the easiest thing someone could is not buy a gas guzzler. That requires no change in driving habits or anything like that.
Which brings me to the crux of the discussion: What are people doing (if anything) about this? I would like to once again ask my readers for their input and feedback. The feedback was overwhelming a few months back when I asked you for your thoughts on inflation. I received dozens of thought-provoking and insightful replies on the topic. I have six questions that I'd like to ask of each of you. They can be answered easily in just a few minutes' time. Since I realize that many of the people that read my column are like-minded, if you have the time and inclination, I'd ask that you take this even one step further. Pose these questions to a few of your friends and jot down their replies. I'd like to form a picture of what we are dealing with in terms of the market's psychology with regard to prices and behavior.
1) Where are you from (city/state) and how much is regular unleaded in your area?
2) Do you pay attention to the price when you fill up?
3) Do you converse with friends in your area and share info about 'cheap' gas?
4) At what price level (if you haven't already gotten to that point) will you change your behavior?
5) How will the price of gas affect other expenditures you had hoped to make this summer?
6) Does your location have any influence over your consumption of gas? (if you live in a rural area do you find yourself planning your trips out etc)
There have been a number of theories floated as to why demand is rising even in the face of increasing prices. Some feel the reason is that Americans believe they are entitled to consume as much energy as possible no matter what the cost. The second theory I've heard is that because of the ease of paying with credit cards, many people don't even pay attention to the cost of the items they buy. Another is that people have resigned themselves to the fact that there is nothing they can do and while they don't like it they might as well just accept it. Whatever the reason(s) happen to be, our actions are ultimately paving the way not only to a continuation of prices at this level, but to even higher prices down the road. I leave you with one last question: How high is too high?
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Andy Sutton holds a MBA with Honors in Economics from Moravian College and is a member of Omicron Delta Epsilon International Honor Society in Economics. This article and other information is located at http://www.my2centsonline.com Please feel free to distribute, copy or otherwise disseminate this information.