Factors, Fluctuating Gasoline Prices

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The case study of the article from Wall Street Journal, dated from March 2008.


In recent years, the world's appetite for gasoline and diesel fuel grew so quickly that suppliers of these fuels had a difficult time keeping up with demand. We all know the situation with gasoline prices for the resent several years. The prices for gasoline had been changed rapidly. Mostly increasing, while the demand for it did not. For example, gasoline prices by Feb. 2008 rose to an average of $3.13 a gallon, that is up to 40% from $2.24 in Jan 2007. ( with the price elasticity 1%/40% = 0,025), and up to 62% from 2003. (with the price elasticity 1%/62% = 0,016). Yet, demand continued to grow at an average 1.15% a year by 2006. Someone could ask why the rise of price did not caused the reduce of demand. The answer is that in this case we face the shift of demand (2003 – 2006) due to increase in customers income, and the cars appeared to be more affordable for most people, especially favorable were huge cars (and very fuel inefficient), that perceived to be more safe and prestigious. As we know, increase in demand for complementary good 1 causes the increase of demand for complementary good 2 (cars and fuel). As cars can not run without fuel. The increase of demand for gasoline was the response to the increased demand for cars, and market responded for that with the increase of gasoline prices (shift in equilibrium price).

Consumers were better able to absorb the increase in gasoline prices and pinch pennies at less price stores like Wall mart and keep driven, because : 1.Consumers could not stop driving, driving could be the last thing they could refuse to do. And they could not drive without gasoline – as there are no substitutes for gasoline (unless they switch for other fuel-source car) 2. Consumers thought that was only shot- term increase in gasoline prices, and consumers expected the gasoline price to return to its previous price pretty soon, 3. Consumer’s income remained at the same or growing level.

Later, in 2008- 2009 we could watch the decreasing in people’s income, prices for gas continued to grow, while the quantity demanded for gas did not decrease as much. According to the article, just 0.6 % decrease in demand in a short term by 2008, when gasoline prices rose 10% from 2007, and 4% cut of demand in long term (if sustained over 15 years).That was the most sustained drop in the demand in 2008 (except for declines from Hurricane Katrina in 2005). We can see the difference in demand cut in short and long terms, as we know the demand is more inelastic in short term, because: - people wait the situation to improve to the better

- they are not customized to the situation and don’t know what to do - can not change a lot of things in short time period.

We, we can calculate the price and income elasticity of gasoline demand. In short run price elasticity for gasoline demand is 0.6%/10%=0.06, and 4%/10%=0.4 for long run. So, we can see now, that price elasticity coefficient is less than 1, or percentage change in quantity demanded is less than percentage change in price change, that means that elasticity for gasoline demand is inelastic. That means that consumers have little responsiveness for price change.

Gasoline prices kept rising together with the reduction in personal income (1% reduction in personal income cuts gasoline demand by 0.5% as consumers. Income elasticity for gasoline demand was : 0.5%/1%=0.5 (normal good, necessity good),

Later, the situation continued to change to the worse, consumers started to react: 1. Consumers turned their life to more fuel-efficient lifestyles. Big, prestigious fuel inefficient cars were replaces by smaller cars and hybrids. Sales on large cars dropped to 10.5% in 2007. And only...
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