source

Will higher taxes on greenhouse fuels affect people’s driving or home heating habits very much? This depends on the elasticity of demand for these fuels. Elasticity of demand is defined as: Percent priceinchange Percent demandinchange demandofElasticity = Economists have measured the elasticity of demand for different fossil fuels, particularly gasoline. One study43 surveyed all the available research on the elasticity of demand for motor fuels and found that within the short-term (about one year or less) elasticity estimates averaged -0.25. 44 This means that a 10% increase in the price of gasoline would be expected to decrease gasoline demand in the short term by about 2.5%. In the long-term (about 5 years or so) people are more responsive to gasoline price increases as they have time to purchase different vehicles and adjust their driving habits. The average long-term elasticity of demand for motor fuels was -0.6445. According to Table 5, a $200 carbon tax would increase the price of gasoline by 48 cents per gallon. Assuming a retail price of $3 per gallon, this would translate to a 16% price increase. A long-term elasticity of -0.64 suggests that once people have time to fully adjust to this price change, we would expect the demand for gasoline to decline by about 10%. Figure 10 shows a cross-country relationship between gasoline prices and per capita consumption. (Since the cost of producing a gallon of gasoline varies little across countries, variations in the price of gallon in different countries is almost solely a function of differences in taxes.) Notice that this relationship is similar to that of a demand curve: higher prices are associated with lower consumption, lower prices with higher consumption. The relationship shown here, however, is not exactly the same as a demand curve; since we are looking at data from different countries, the assumption of “other things equal”, which is needed to construct a demand curve, does not hold. Differences in demand may, for example, be partly a function of differences in income levels rather than prices. Also, people in the United States may drive more partly because travel distances (especially in the Western U.S.) are greater than in many European countries. But there does seem to be a clear price/consumption relationship. The data shown here suggest that it would take a fairly big price hike – in the range of $0.50- $1.00 per gallon or more – to affect fuel use substantially.