An Inelastic Snap

A barrel of crude oil has nearly doubled in price in the last two years, and retail prices of about $4 per gallon are around 50% higher than just a year ago.

And most people shrug and pay it?

This would be called a perfect example of inelastic demand in the parlance of economists, meaning that consumption doesn't seem all too sensitive to pricing.  Cost goes up or down, but folks -- maybe not all, but certainly a vast majority of consumers -- just keep on buying.

The media can't provide a rational explanation for what's going on.  Nobody fully accepts (or understands) wan references to China needing more oil, or America needing to swap pristine wildlife reserves for drilling derricks.  If supplies are really getting tight, why is it that not one expert predicted the demand? The vaunted mechanism of the free market seems to be in full catch-up, or reaction mode.

But to what is it reacting, exactly?  I find this lack of a clear, concise, credible answer rather incredible.

What's more amazing, though, is that consumers seem willing to overlook this oversight and, shockingly, continue to consume the stuff like it is going out of style (which it very well might be).

What does this tell us about how people make choices?

• We don't weigh options too well. So how many of us are driving less because gas costs so much more?  OK, maybe some people, but not many, according to the consumption figures (the oil companies are selling all the gas they can deliver).  As a 50% higher expense, you'd think consumers would see some trade-offs revalued, and perhaps change their behavior?  One trip to the mall instead of two?  Combining errands to a single journey?  Biking or walking instead of driving to a close-in destination?   
• We compartmentalize. What if we consciously considered that the oil companies will soon be doubling the money they charge us for the privilege of helping to destroy the planet?  Wouldn't that affect our refill intentions ever-so slightly?  Now, count all of the impacts of rotten traffic (delays, aggravation, risk and cost of accidents), and it's almost like we wear one "head" when we drive, and another when we choose to think about all those other things that supposedly matter to us (or that we consider a bother). 
• We really don't remember things for long. Weren't you pretty shocked and/or angry when you realized that filling your gas tank cost so much that first time?  I bet you felt less so the second time, and by the time you reached the 10th refill, you barely shrugged your disapproval.  When the newscasters proclaim that oil prices have declined a few pennies, should we feel relieved?  It just means that the cost may level, or go down slightly.  But does anyone remember...truly remember, as in an active realization...how cheap gas used to be?

Remember, I'm talking about the same consumers (you and me included) whom we hope will be aware of our branding, absorb and contemplate it, and then apply what we’ve promoted to their purchase decisions. 

Uh oh.

While the snap of this inelastic demand of ours for gas might sting, it isn't prompting a broad overhaul of our behavior that I'd expect (and wish) to see.   Bulbs brighter than I am should be talking about why.

Maybe the price has to reach some as-yet unimagined threshold (like the prices Europeans pay?).  Perhaps we’ll take action when we see the impacts of costly oil ripple through other industries (airfare is going to keep getting expensive; retailers will possibly start raising prices to help defray shipping costs, etc.).

But so far, it's just revealing how difficult, imprecise, and utterly confounding the influences on purchase behavior can be.

Comments

[chris demeyere]

I expect you know this, but I still wanted to point it out. In the top 3 of commodities humans value most, you will find comfort. Why are people paying the highter gas prices? Why don't they act like logical economic agents? Because humans are not logical economic agents. We will not always prioritize based on price.

And if prioritizing is hard and complicated, many won't do it. What can people do? Drive less? Transportation is vital to most people, they need to get to work, need to do shopping... Is there really much room to easily squeeze a few cents? And, what needs to be sacrificed? We could buy more fuel-economic cars, but that is but one aspect of choosing a car. Image, brand, safety, comfort... all play into that choice. And who is going to replace a car just to buy a greener one? A car tends to last years. So, driving less, or driving greener, are uncomfortable, difficult choices. They require effort. It is rather easy to postpone that decision infinitely, even tough you know what is going on and that you should in fact upgrade to a green model, that you should in fact try out carpooling, maybe you don't need to shop in three different places, maybe instead of going out to the movies, you can get netflix...

And thus, we see people choosing for comfort. Oh sure, when their car gives in and they buy a new one, and that car is both green AND cool AND usable, they may be tempted. Because then it will be comfortable and easy to comply with morality, and saving money on fuel will be a big plus.

Untill then, i think the demand for petrol is going to prove itself to indeed be price inelastic.

[Ethan Chatov]

Jonathan:

I enjoyed this article, but I kept waiting for you to address the decline in demand for SUVs.

http://online.wsj.com/article/SB112810411178056944.html

My opinion: the main problem is that the US never prepared itself for this eventuality. While Europe and Japan were developing efficient public transportation systems, we continued to follow the system set up under Eisenhower's administration that disassembled light-rail systems in cities across the country, instead emphasizing highways and roadways catering to the individual car owner (and the American auto industry) and encouraging a nationwide shift of urban populations to the suburbs. We morphed into a nation of endless strip malls and the "new American city" became typified by the sprawl haunting the landscapes of metropolitan centers like Houston and Phoenix. Very few states and cities implemented urban growth boundaries (Portland, where I live currently, is one of the few) that encouraged the construction of efficient public transportation systems. The result: our country lacks the infrastructure necessary for most people to give up their cars, our cities are so geographically vast that the construction of public transportation systems is prohibitive, and consumers are still stuck with long commutes to work that can only be accomplished via automobile.

So of course consumers are still paying for gas at whatever price they give us...we literally have no choice in the matter. But the decline in SUV sales and the sudden increase in SUV's available via the used auto market indicates that consumers are doing whatever they can to minimize the costs.

Not that you asked, but I just wanted to chime in. Maybe I missed your point entirely....

[mhovorka]

Chris, agreed, it's a confluence of factors. Of the three people I know who recently changed cars, all three made greener choices. One switched from an SUV to a used Saturn (could not afford a Prius, but wanted better fuel economy). One switched to a Prius (she has a 45 minute commute each way every day). The third decided to keep her car for another year to save up some more money for a down payment and to wait and see what other cars come on the market since she doesn't like the Prius. If the timing is right (meaning, time to get a new car), I am seeing people making green choices.