Tuesday, July 1, 2008

Higher Oil Prices and Marginal Consumption

It is well known that demand for oil and petrol is inelastic. Higher prices reduce demand by only a small %. The reason is that petrol consumption is a necessity for many who have to drive to work. However, just because it is inelastic doesn't mean that higher prices won't reduce demand.

Why Higher oil prices are reducing Marginal consumption.

  1. Some journeys are inessential. e.g. Rather than go for a leisure drive on Sundays, you could go for a walk to the local park. Rather than drive to the supermarket you could pay for it to be delivered to your house.
  2. Petrol saving tips. When petrol is cheap, people think nothing to speeding along motorways at 90mph and accelerating fast. - Time is more important than the cost of petrol. However, when the price rises 50%, the cost of petrol becomes more valuable than time saved. Therefore, people are cutting down on speeds; they are trying to drive more conservatively. There is a fascinating article here about how the UK is slowing down. Planes, trains and boats are all cutting their speeds in an effort to save fuel costs.
  3. Tipping point. If petrol prices rise 5%, there is little incentive to change your behaviour. However, if they rise 50% and look like staying high, it starts to make people think about the long term. It is when this tipping point is reached that people may consider radically changing their behaviour. (see how to save petrol costs)
  • Buying a bike
  • Car sharing
  • Going by Train.
  • Not Buying an SUV but buying the most fuel efficient car.
  • Not filling up when tank is half empty (American AA is reporting a record number of motorists running out of gas as they try avoiding filling up until next pay day)
It may only be a small % of car owners who make the radical change, but, it is enough to start reducing petrol consumption significantly. In the short term demand is highly inelastic, but over time demand becomes more elastic. Higher oil prices may not change the behaviour of all consumers, but, they will change the behaviour of some. The higher oil rises, the more people will consider changing their behaviour.

The interesting thing is that many of these change in behaviour have beneficial impacts for congestion, the environment and safety. Maybe higher oil prices are a blessing in disguise.

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