On the price elasticity of gasoline

Statistics Canada’s economic review of 2006 contains an interesting passage about consumer responses to higher gas prices. One would expect that as gas prices rise, drivers would consume somewhat less gas in the short run (gas demand is inelastic, so the reduction may be small), and to change their behaviour over the long-run by purchasing more fuel efficient vehicles. This appears to be the case in the US, but Canada is an anomaly. Not only are we consuming more gas in response to higher prices, but are purchasing ever more gas-guzzling trucks and SUVs. This must be because demand conditions (robust economic growth, low unemployment) are so strong that they are swamping the price response.

Here’s what the article has to say:

Since 2002, the price of a barrel of oil on world markets has jumped from $20 (US) to a peak of $77 last fall, before easing to $60 at year end. Consumers in Canada mostly shrugged off the effect of rising gasoline prices on their driving habits, never mind their overall behaviour. Retail gasoline consumption has continued to increase every year since 2002, including a 0.8% rise last year. The only concession drivers made to higher prices was to switch from premium to regular grade gasoline in each year.

This is in marked contrast with the US, where households consumed less gasoline in both 2005 and 2006, their first back-to-back declines ever outside a recession. The different impact of gasoline prices on the two countries was reflected in consumer confidence. Soaring gas prices dampened spirits in the US but not Canada, opening up the widest gap in confidence between the two ever recorded.

Neither did rising gasoline prices broadly affect the level or composition of vehicle sales. Overall, unit sales were the second highest ever, just 4% below the record set in 2002. For the fifth straight year, purchases of trucks (which include SUVs) rose faster than car sales. While demand increased for some segments such as subcompact cars, demand continued to grow for large and luxury SUVs and crossover vehicles (SUVs mounted on a car chassis). In fact, the strength of truck sales pushed the share of cars in all vehicle sales to a record low of 51.7% last year (eclipsing the previous low of 51.8% set during the oil price collapse of 1998).

The relative strength of truck versus car sales in Canada was the opposite of the US, where consumers switched to cars (notably hybrids) to save on fuel in the last two years. Much of the difference between the trends in the two countries can be attributed to Alberta, where two-thirds of all vehicles sold last year were trucks.

3 comments

  • It is generally accepted by the Canadian public that we are being ruthlessly gouged on the price of gasoline all across this country, and that our governments of whatever political stripe are complicit in that process. There is also prevelant an air of weary resignation that there is nothing ordinary people can do about it. As long as that attitude prevails, nothing WILL be done about it. That’s for sure. It is extremely disingenious to suggest that Canadian travel habits, or even our choice in vehicle purchases could affect the price of gas in any way. With a continentalized, even globalized gasoline market, Canada is such a bit player volume-wise that if everyone in the country stopped driving tomorrow it wouldn’t make enough difference to overall gasoline demand to bring the price down even a nickel a litre. Domestic political action is the only option. We cannot even hope for that from either Liberal or Conservative governments. And we are clearly not ready to vote our own interests and make the difficult political choices that might make a difference. So we will keep on paying and keep on grumbling, and nothing much will change.

  • Mr. Burton seems to have missed the point of the commentary: it is not about why gas prices are high (about this I agree) but the fact that with a significant price rise our consumption has continued to rise, and vehicles with poor gas consumption are as popular as ever. There has been no discernible change in behaviour. This tells me that the price of gas is still to low to effect behaviour and will continue to rise until it is low enough. This will be accomplished through gas taxation or expanding profits. Personally, I prefer taxes that can be spent on transportation alternatives.

  • Considering the price-elasticity of demand appears to be quite low, the price of gas is still in the middle range of the demand curve. Simply put then, to get high enough responses to increases in gas prices, the price has to get closer to $2+/litre.

    When the price gets that high, a percentage-point increase in price should start causing an equal-to or greater-than decrease in demand. In effect then, to make people use less gas, we have to get the price considerably higher, like in Europe.

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