analyticsbox | Dec 29, 2021
Elastic vs. Inelastic Demand Factors
Pump sticker shock anyone? We have all seen prices change dramatically this year for many items. From homes and hamburgers, to groceries and gas. After many years of relatively stable prices (averaging 2%+or- inflation), things have changed rapidly in 2021. And gasoline prices have risen almost 60% in the last year. Other prices have risen but not as much and with not as much impact. So why is that and why is gasoline impacted so much more?
A fundamental in economics is the law of supply and demand. In a free market, this interaction is what determines the price of a good or service. It is real and all attempts to change it, such as with price controls, do not work. (For explanation of Supply and Demand, see Video #5 on our website).
Gasoline is a unique commodity relative to others as the demand for it is ‘inelastic’. That means that the change in demand is relatively small in relation to the change in price. Think about it this way, if the price of an orange doubles, you can stop buying oranges and substitute something else. But if gasoline prices double, you still have to go to work or take the kids to school and many other things that are not easy to change in the short run. So you still buy gas and perhaps you change some things to reduce use of gasoline, but these are limited. In the short run, demand for gasoline is ‘inelastic’ and does not change proportionately with a change in price.
So when factors change the supply of gas modestly, the price will go up disproportionately because we cannot wean ourselves off the use of this commodity that fast. Demand will come down some as we economize, but until the price gets way too expensive, we will still use a lot.
Government policy this year has focused on limiting our supply within the U. S.. Most people have no choice but to continue using gasoline, so the demand is high relative to our supply and that is why our gas prices have risen quickly. There is a world wide market for oil and unless other countries increase production to offset our decrease, the price will stay high and could go higher. It all depends on world wide supply and demand.
THE BOTTOM LINE
It is clear that the law of supply and demand works well in a free market economy. It is also true that for commodities with inelastic demand, in the short run, it is difficult to change consumption patterns. Government policy must recognize this when it meddles with the market to limit supply and it is this interference on the supply side only, which is driving up what you pay at the pump!
UNDERSTAND ECONOMICS, THEN VOTE SMART