On the price-elasticity of demand for petrol

I made the mistake, last semester, of asking the following in a mid-term exam

If the price of gasoline doubles while your income is constant:

A) Consumers substitute gasoline for other products you once consumed.
B) Consumer purchasing power has decreased and consumers buy less of everything.
C) Consumers will continue to buy exactly the same amount of gasoline.
D) Consumers’ consumption of all goods will remain exactly the same.
E) None of the above.

I was taught the trick of ‘none of the above’ by a colleague – if you’ve cocked up and none of your answers are correct, you’ve got the mistake covered. If you’ve cocked up and more than one of them is correct, of course, you still have a problem – but that’s easier to cover.

I say the question was a mistake. It wasn’t as such, it was just setting my students (first-year) up with some unnecessary confusion over attitudes towards petrol, demand for which is relatively price-inelastic, not perfectly price-inelastic. Price elasticity works thus:

We compare a 1% increase (for example) in price, to the subsequent decrease in quantity demanded. It can be greater than the 1%, less than the 1%, or equal to 1%:

I know there are errors in those numbers. I’ve informed the authors of the book. When a 1% increase in price generates a less-than-1% decrease in the quantity demanded, demand is relatively price-inelastic: it is relatively non-responsive to price changes. This is not the same as completely non-responsive, which is when price changes but the quantity demanded does not:

To be fair, answer A) is a little confusing, but students who went with C) didn’t know why (obviously, because they were wrong). As far as they were concerned, would one not just keep driving? And pay more (my University has rather few students below solid middle-class, I should add)? Those who answered D) really needed things explained to them. Such are the fortunes of changing the perspectives of students into those of economists.

The confusion, of course, was that they were probably right (on aggregate I am right – but I doubt my students have much experience of all the income groups that make up the aggregate). From today’s drumbeat,

Global warming may be the nation’s latest roadside attraction, but the American obsession with the carbon-spewing automobile still seems to be charging full speed ahead.

Seventy-seven percent of workers in the United States – more than 102 million people – drive alone to and from work, up from 1990, according to recently released US Census data, based on surveys conducted in 2005. This happened despite the fact that retail gasoline prices rose by 60 cents per gallon in that same 15-year period, controlling for inflation.

Huzzah! For the Christian Science Monitor not beginning a sentence with Arabic numbering. So carpools are down, public transit is down and walking is down. Super.

I had a related conversation with a colleague a while back – while I was griping about 4WDs, he explained that they in fact have the potential to be better – although they have poorer fuel-efficiency, they can carry more people, and do more things. I pointed out this (at the time anecdotal evidence) phenomenon: they’re not. I agree with him, though. Absent any leadership from anywhere, SUVs and so-called people carriers could actually make quite a bit of difference, both in total fuel consumption directly, and indirectly by reducing traffic during peak travel times. Carpoolers could even do their shopping together (I used to, with housemates – I also don’t drive, so my incentives are structured differently).

Take the bus…and shove it?

So why did public transport decline during this period? Increasing populations, increasing density, urban and suburban expansion – sounds like a recipe for controlled sprawl and public transport systems to me? Apparently not.

Nine out of ten American adults claim they are paying close attention to the rising cost of gasoline, according to a Discover survey. In fact, two-thirds can quote the per gallon price within 30 cents. While nearly half of car owners said they are willing to buy a more fuel efficient car should gas prices increase $1, a strong majority ruled out using alternative transportation to offset rising gas prices and are more likely to cut discretionary spending.

…

According to the survey:

• 70 percent of car owners said they will cut back on entertainment spending if gas prices were to increase a dollar,
• 66 percent said they will change their vacation plans, and
• 64 percent said they will postpone a major purchase
• 61 percent were not very or at all likely to walk or ride a bicycle
• Less than one in four (24 percent) were somewhat or very likely to take public transportation

I have the benefit – mostly – of living in two areas: New York City and Bethlehem, Pa. Public transport in New York City is excellent, a significant and accepted equaliser, efficient, you name it. I’ve seen clear-wealthy children refuse to get on a bus, insisting their nannies hail a nowhere-to-be-found taxicab in the rain (I’ve never once pushed them under that bus). I’ve also taken the bus in Bethlehem, to other towns and to a very depressing shopping mall. I even took Amtrak to Toronto, to elope.

I couldn’t even begin to describe the difference. Trains are fairly rare, outside major metropolitan areas. For whatever national mental defect there isn’t a train service from New York to Allentown. Buses for the metropolitan area in Lehigh valley are not the M86. They provide transport for the people who don’t drive. Which is to say, significantly poorer, less employed (and, in my experience, crazier) than the rest of people.

My point is that public transport in a lot of this country is a relatively (which I stress – buses in Bethlehem don’t smell, or break down, are carry lunatics who’ll stick you with a needle or anything) unpleasant experience, for most people – moreso for the generations of people who’ve grown up with cheap oil, 2-car families, etc. Driving is more inextricably tied to practical freedom than the American flag, of which I see hundreds per day, could ever hope to be. The results of the Discover survey are perfectly reasonable. Which is rather worrying, because it indicates that nobody, at any level, is doing anything about the problem.

Sales of new houses, too

The numbers is out – and they is not good (?). Sales of new houses fell 1.6% on last month (and last month was also lower than expected). Higher falls in metropolitan areas.

Sales of new homes were down 16 percent from the same time last year. The number of homes that are completed and waiting to be sold fell by 2,000 to 177,000.
…
A jump in mortgage rates this month and a glut of unsold properties on the market will continue to discourage home construction, economists said. The housing slump, already the worst since 1991, will restrain the economy for the rest of the year and potentially into next.

“The housing market should continue to be a drag to growth,” said John Shin, an economist at Lehman Brothers Holdings Inc. in New York. “Excess inventories and soft demand should keep homebuilders from increasing construction until after next year.”
…
Home prices in 20 metropolitan areas dropped 2.1 percent in the year ended April, the biggest year-over-year decline since record keeping began in January 2001, according to a report today from S&P/Case-Shiller. The decline was led by a 9.3 percent drop in Detroit and a 6.7 percent fall in San Diego.

Quick piece of economics: lower demand means increasing supply (for things like houses – more of which are going on the market, to boot).

Lennar Corp., one of the nation’s leading homebuilders, said Tuesday it fell to a second-quarter loss as inventories of unsold homes rose and it had to cut prices to attract buyers. Lennar also warned that it would likely post a loss in the third quarter as well.

“As we look to our third quarter and the remainder of 2007, we continue to see weak, and perhaps deteriorating, market conditions,” Lennar President and Chief Executive Stuart Miller said.

Losses totaled $244.2 million, or $1.55 per share, versus a profit of $324.7 million, or $2 per share, in the previous year.

Lennar shares fell 19 cents to $38.56 in mid-morning trading.

That’s a higher price-drop (though a lower percentage) than Queen’s Walk faced yesterday – but then, Queen’s Walk was moving away from this sort of thing. Lennar Corp. builds houses, and that trend suggests that, safe though houses might be, profits from them are going the way of profits from buying and selling the mortgages on them. Lennar Corp. has certainly lost a lot of money in one year.

The Bloomberg article also mentions profits at Bed Bath & Beyond Inc. being lower than forecast, even while Fed chairman Bernanke says the softness in the housing market, as well as the tightening of rates and credit, are not spilling over.

Bloomberg’s Housing Recession (the wire service, not the mayor of New York) may well hold for a while. The deficit is widening but manufacturing is up, which helps limit the effects of less borrowing. Then there is the still-ready access to easy borrowing, that the Bank for International Settlements would like to see shut down.

This isn’t exactly the same as the whole sub-prime lending …thing. That is a situation in which a lot of people were sold mortgages that banks should have known they couldn’t afford. In the meantime the debt was itself sold, and different people are suffering the defaults. It does have the effect of widening the exposure to the problem, but then misery loves company. This is a situation in which confidence is low, borrowing is finally taking its toll, inflation is real but real wages aren’t moving – it’s harder to afford to buy a house, basically. Unfortunately one problem is leading towards a shake-out of the capital market that isn’t really dependent on the core value of stocks (it seems), and the other is leading us towards a shake-out of earnings, profits, and a shake-out of the rest of the stock market that is. Ouch.