EIA: price of gasoline tends to have little effect on travel demand; price elasticity has fallen

15 December 2014

The 28% drop in the US average retail price of gasoline since 23 June may not have much effect on automobile travel, and in turn, gasoline consumption, according to an analysis by the US Energy Information Administration (EIA). Gasoline is a relatively inelastic product—i.e., changes in prices have little influence on demand—and has become more so over the past few decades.

<!——>

The US average retail price per gallon of regular motor gasoline has fallen 28% from its 2014 peak of $3.70 per gallon on June 23, to $2.68 per gallon on December 8, with no noticeable uptick in travel. Source: EIA. Click to enlarge.

Price elasticity measures the responsiveness of demand to changes in price. Almost all price elasticities are negative—i.e., an increase in price leads to lower demand, and vice versa. Air travel, especially for vacation, tends to be highly elastic: a 10% increase in the price of air travel leads to an even greater (more than 10%) decrease in the amount of air travel. Price changes have greater effects if the changes persist over time, as opposed to being temporary shocks.

Automobile travel in the United States is much less elastic, and its price elasticity has fallen in recent decades. The price elasticity of motor gasoline is currently estimated to be in the range of -0.02 to -0.04 in the short term—it takes a 25% to 50% decrease in the price of gasoline to raise automobile travel 1%.

In the mid 1990s, the price elasticity for gasoline was higher, around -0.08, meaning it only took a 12% decrease in the price of gasoline to raise automobile travel by 1%.

EIA’s Short-Term Energy Outlook (STEO) uses a price elasticity of -0.02 to estimate and forecast consumption of motor gasoline, while also considering anticipated changes in travel demand and fuel economy. The December STEO expects that gasoline prices in 2015 will be 23% lower than the 2014 average, and consumption in December will be virtually unchanged from year-earlier levels, as increased fuel economy balances out increases in vehicle miles traveled in response to lower prices and other factors.

Price elasticities can be difficult to interpret, as demand can change for reasons beyond changes in fuel price, including changes in other economic factors (e.g., income), demographics, driver behavior, vehicle fuel efficiency, and other structural factors. EIA suggests some possible explanations for the decline in gasoline price elasticity in recent decades include:

• The slowing of per-capita vehicle miles traveled (VMT). After increasing for decades, VMT per capita slowed in the late 1990s and even declined in recent years.

• The retirement of the baby boomer generation, because retirees tend to drive less than the working-age population.

• Population migrations to urban area, as opposed to rural and suburban areas, because urban residents typically drive less.

• Declines in licensing rates for teenagers, as young people delay or avoid getting their drivers’ permits and licenses.

• The reduced share of household income devoted to motor gasoline expenses. As gasoline represents a smaller share of household expenditures, drivers may be less sensitive to fluctuations in price.