Price Elasticity of Demand

Topics: 1973 oil crisis, Peak oil, OPEC Pages: 6 (2321 words) Published: April 6, 2007
In recent years no economic topic has commanded more attention and elicited more emotion than the rising price of gasoline in the United States. Major storms in the southeastern states in 2005 and the ongoing strife in the Middle East have caused the price at the pump to rise to record levels at times and to stay high for extended periods of time. I intend to show how the recent fluctuations in the price of gasoline in the United States apply to the basic economic principle of Price Elasticity of Demand. I will show, through research of economic data how the demand for fuel has responded to the sales price at the pump in recent years as well as during the oil crisis of 1973 and 1980. 1973 -1974 Arab Oil Embargo

First, let us start with a bit of history. Although the recent rise in price at the pump has been a burden on most of us, the economic and personal impact seems to have been far less than that of the oil shortages in 1973 and 1980. In 1973 Arab oil exporting countries refused to sell oil to nations that supported Israel in the Arab-Israel war. The effect of this decrease in supply in the United States was dramatic: "Within a few months, the price of oil went from around $3 a barrel to about $12. That sounds like a bargain, compared with just over $70 in April 2006. But expressed in today's dollars, the price went from around $10 a barrel to $40 a barrel. That's a huge increase and the impact on the global economy was devastating." (CBC News) In the years to follow, after the oil embargo was lifted, the price of oil fell, but failed to recede to the levels observed prior to 1973. In 1973 the average price for a gallon of Regular Leaded gas at the pump was $0.39. In 1974, effected primarily by the oil embargo, the average price rose to $0.53. After the embargo, in 1975, the average price of a gallon of gasoline was at $0.57. (Figure 1) Between 1973 and 1974 the average price of a gallon of gas at the pump rose by approximately 35.9% and by 1975 the average price was approximately 46.2% higher than in 1973. (EIA – Table 5.24) In 1973 the average consumption or quantity of gasoline demanded was 6,496 Thousand Barrels per Day. In the years leading up to the oil embargo, the quantity demanded was increasing steadily year to year. In 1974, the consumption of gasoline dropped to 6,372 . This drop of 1.9% was the first drop in the average gasoline consumption during any of the previous 25 years. In 1975, after the effects of the oil embargo were lifted the average consumption of gas was 6,512*. (EIA – Table 5-13c) The Price Elasticity of Demand for gasoline during the period between 1973 and 1975 was 0.005 or very inelastic. But from 1973 to 1974 the Price Elasticity was 0.05 which is still considered inelastic but 10 times more elastic than the longer period from 1973 – 1975. The oil embargo decreased the average consumption of gasoline during the period from 1973 - 1975, but the quantity demanded continued to rise unabated for a few more years until it reached 7,264 in 1978. 1979-1980 Energy Crisis

In 1979, unrest in Iran led to yet another spike in the price of oil. "Oil went from a little less than $15 a barrel to around $35. In today's dollars, that's like boosting the price of oil from about $40 a barrel to $80." (CBC News). This translated into an average price for a gallon of gasoline rising to $0.86, a 36.5% increase from the average of $0.63 charged in 1978. The effects of this energy crisis lasted for a much longer time than the situation in 1973. The price for a gallon of fuel continued to rise and in 1980 hit $1.19 a gallon, an 88.9% increase. In 1981 the price of a gallon of gasoline reached $1.31, a 107.9% increase over the average price paid in 1978. (EIA – Table 5.24) As in 1974, the consumption of gasoline dropped in 1979 and 1980, but unlike the previous crisis, the quantity demanded dropped sharply and stayed low for many years. In 1978 the average daily consumption of gasoline was 7,264*....
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