Question

Use the following information to work Problem1 a) and b).

Why the tepid response to higher gasoline prices?

Most studies report that when U.S. gas prices rise by 10 percent, the quantity purchased falls by 1 to 2 percent. In September 2005, the retail gasoline price was $2.90 a gallon, about $1.00 higher than in September 2004, but purchases of gasoline fell by only 3.5 percent.

Source: The New York Times, October 13, 2005

1.   (2 points) Calculate the price elasticity of demand for gasoline implied by what most studies have found.

2.   (2 points) Compare the elasticity implied by the data for the period from September 2004 to September 2005 with that implied by most studies. What might explain the difference?

Answer 1

1.

According to most studies:

If US gas prices rise by 10% then Quantity purchased falls by 1 to 2%.

If Quantity falls by 1% then:

Price elasticity of demand= % change in Quantity / % change in price

Price elasticity of demand= -1/10= -0.1

or

If Quantity falls by 2% then:

Price elasticity of demand= % change in Quantity / % change in price

Price elasticity of demand= -2/10= -0.2

2.

From September 2004 to September 2005:

In September 2005, Price= 2.90

In September 2004, it was $1 less than the sptember 2005 price, so Price in september 2004= 1.90

% change in price= [(Change in price)/Price in 2004] x 100= (1/1.90) x 100= 52.63%

Price elasticity of demand= % change in Quantity / % change in price= -3.5/52.63= -0.06

The demand is less inelastic according to the reports as compare to elasticity from september 2004 to 2005. The reason can be that reports taken into account the other factors as well which can have an impact on demand for gas.