The high or low use of gasoline is, no doubt, related to the health of a nation and the world at large. The world is holding discussions at governmental levels to consider the introduction of electric cars to reduce carbon emissions that go with high gasoline use in cars. As we have discovered, understanding the price elasticity of demand of gasoline would help us change driving habits in the long run. Hence, effective societal change is possible only after a thorough consideration of economic facts.
Given that an understanding of the price elasticity of demand could even change the world in a positive way – this economic concept is a very important one to learn about. In this paper, therefore, we will discuss this microeconomic concept in relation to different products and services, mostly with the use of evidence presented in recent articles published in newspapers and magazines. A thorough understanding of the price elasticity of demand is expected to help all kinds of businesses achieve their goals.
Everybody in our world is a consumer of goods and services. And, each one of us understands the price elasticity of demand, without always being consciously aware of the fact that this concept is in fact one of the most important concepts studied by economists all around the globe. Tim Harford is an ex-economics tutor at Oxford University, who also writes the “Dear Economist” column for the Financial Times Magazine and works for the World Bank in Washington as a lead writer on economics. According to his book, The Undercover Economist:
The savvy consumer sees…the wisdom of comparison shopping. He spots the role of price elasticity in supply and demand in the way that, say, Disney World discounts admission tickets by more than half to Orlando locals than that charged to mostly out-of-state tourists. The Disney people know locals are more likely to come regularly at a reduced price while the tourists are relatively price-insensitive and will likely still come at least once, even if the price is a bit steep (Peterson 85).
Every consumer realizes that when the price of a demanded product or services increases, he or she would like to turn to similar products or services that are supplied by other producers or providers of service. If all producers or providers of a particular service increase their prices together, however, the consumer may plan to give up the use of that particular product or service, provided, of course, that the demanded product or service is not a necessity in his or her life.
This concept has been utilized by researchers studying the effects of increasing the price of alcohol on the demand of the product. According to an article in the Winter 2002 issue of Alcohol Research & Health, the price elasticities of demand for beer wine, and distilled spirits are -0.3, -1, and -1.5 respectively. These estimates have suggested that beer consumption is relatively insensitive to price changes, whereas the demand for wine and distilled spirits is elastic. Increases in the monetary price of alcohol do in fact reduce alcohol consumption among youth and young adults. The article also reports that increasing the price of alcohol can reduce the frequency of diseases, injuries and deaths related to alcohol use and abuse. Drinking and driving may be reduced among all age groups. In addition, alcohol-related violence and other crime may be checked by increasing the price of alcohol, especially the price of wine and distilled spirits (Chaloupka, Grossman, and Saffer, 28). Thanks to our understanding of the price elasticity of demand, once again, we are able to change in our world in a positive way.
Shell Gasoline, the company chosen to focus on in this paper, infamously has the highest prices for gasoline; however, Shell is also known as a high-quality provider of gasoline. Therefore, while Shell gasoline’s pump prices demonstrate they are the highest, that does not mean they have necessarily suffered the biggest increase over the years. In fact, Arco gasoline, typically known as the cheapest service provider (and not necessarily the provider of high quality gas) has jumped the most. Chevron, on the other hand, falls in the middle of the price comparison. Currently, as of May 5, 2011, Shell prices for 92 octane gasoline are $4.56, Chevron is $4.44, and Arco is $4.34 per gallon. (However, this is subject to fluctuation based on time of day).
So, the question is, what is better to provide? Cheaper gasoline or high-quality gasoline? It certainly depends on one’s target audience and the state of the economy. Currently, with the economy recovering but still in a disrupted state, Arco is leading the way, of the three companies discussed. This does not mean that Shell and Chevron are faltering; what it does demonstrate, however, is that trends in the economy not only affect price elasticity, but the type of gas individuals will buy. Some people are faced with a choice between gasoline and food, or gasoline and paying their electric bill; in such a situation, we can understand why they would buy Arco gas. At that point, Shell’s concept that high quality gasoline is the best no longer matters to the individual.
The protection of the environment or the ecology of the planet is a hot topic of discussion around the world. From the World Economic Forum 2006 in Davis, Switzerland, to the United Kingdom government’s Securing the Future: Delivering UK Sustainable Development Strategy, everyone seems to be concerned about the global environment (Defra 25). As we have discussed, an understanding of the price elasticity of demand for gasoline may help us achieve our goals for the environment, one of the most significant one of which is the reduction of pollution, including carbon emissions. By substantially increasing the price of gasoline for the next five years, the United States – one of the most important consumers of gasoline – may decrease the demand of gasoline among its consumers, thereby reducing carbon emissions and pollution in the world. All the same, the world does not seem to be ready as yet to reduce its demand for oil following a significant increase in its price.
In June 2006, oil prices went over $72 a barrel due to concerns over disruptions to gasoline supply during peak summer demand in the United States. However, the demand for oil remained robust (Chatterjee 26). Two years before, Neil Chatterjee (2004) had reported that “governments around the world are helping sustain rapid oil demand growth by subsidizing fuel or keeping duties low – limiting bills for consumers to avoid a public backlash over record prices.” In other words, the world does not appear ready even to hail the idea of significant increases in oil prices. And so, governments around the world expect a hue and cry whenever prices of oil are increased significantly for some reason.
Even though the price elasticity of demand for gasoline is quite low in the short run, economists have already estimated that the demand of gasoline can be substantially reduced if the price of gasoline rises significantly and remains high for at least five years. Governments around the world can use this information to reduce carbon emissions or pollution around the world. To achieve this goal, it is equally important for governments to educate the global public about the dangers of high consumption of gasoline. The fact remains: an understanding of the price elasticity of demand for gasoline can work wonders for the environment and ecology of our planet. The knowledge of demand elasticity is, in fact, indispensable!
An understanding of the price elasticity of demand for products and services is essential in the business world. In point of fact, this knowledge is weighty enough to change our world, as we have seen from the examples of alcohol and gasoline. Significantly increasing the price of certain alcoholic products can reduce violence, crime, accidents and other losses in our world. And, substantially increasing the price of gasoline over a long period of time – at least five years – may significantly improve the environment and help the ecology of our planet by reducing the demand for gasoline and therefore carbon emissions that harm our planet greatly.
All consumers are responsive to changes in the prices of their desired products or services that are not necessities. Even in the case of necessities, consumers may sometimes have to give up their need for desired products and services if in fact the prices of these products and services are too high for them to pay. We all know that countless poor people in the developing world die everyday because they cannot afford to buy expensive antibiotics!
Price and demand would always have a relationship. And all businesses understand the meaning of price elasticity of demand even if they have not as yet consciously applied this essential concept to increase their understanding of how to conduct better business.
Price elasticity of demand is an everyday concept applying to all people around the world. Increased awareness of this concept in addition to correct measurements of demand elasticity may not only help in making our world a safer, healthier, and better place, but also give a massive boost to the global economy. We only need to imagine a world where all businesses use a correct estimate of demand elasticity to understand the kind of changes that an understanding of this basic microeconomic concept could bring about!
Chaloupka, Frank J., Michael Grossman, and Henry Saffer. (2002). “The effects of price on alcohol consumption and alcohol-related problems.” Alcohol Research & Health. 2007. Web.
Chatterjee, Neil. “Governments Subsidize Oil to Escape Backlash.” The Birmingham Post. 2004, p. 25.
Defra, Bryan. “Securing the Future: Delivering UK Sustainable Development Strategy.” 2006.