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August 04, 2008

Elasticity and gas prices

There's a major concept in economics called price elasticity of demand. Some economists say this concept is at the root of understanding why gas prices have gone up so much this year. Let us in on the secret.

Dr. Mike Walden, North Carolina Cooperative Extension economist in the College of Agriculture and Life Sciences at N.C. State University, responds:

"Well, it's not a big secret, but for most products that we consumers buy, if the price goes up, we buy less. Now, this year in the world, the world has been trying to buy more gas and oil than is available. So we definitely have seen a price rise, but we've seen a big price rise because oil and gas, I think most people would consider to be necessities. And this is where the concept of price elasticity of demand comes in. For a necessity, you have to have a gigantic rise in price for people just to reduce their consumption by a little bit. So, for example, this year, the world has been trying to buy 5 percent more oil and gas than there is available, someone's had to reduce their consumption. What we could have very well seen - and, indeed, we have seen - is a big price increase - 35 to 45 percent up - in order to get us to have that rather small 5 percent reduction. And this is typical, again, with something like gas and oil. With something like beef, not so much. You could have a very small price increase, and people would reduce their consumption because they would go to another product. So I think economists are arguing that this simple concept rather than something like speculation is the root cause of why we've seen gas prices go up so much this year."

Posted by Dave at August 4, 2008 08:00 AM