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Thursday, July 10, 2008

Pigou is Gassy

This post is in response to Mankiw's post on gas elasticity, and in response to a friend's request to offer a concise offense against Pigouvian taxation.

I don't buy all this talk of a strong price elasticity of demand with respect to gas. Studies show elasticity for gas to be extremely weak at best - these few cases cited by Mankiw, media outlets etc. about people moving to scooters, or online classes, etc. are undoubtedly true as gas has shot up dramatically over the past year (the effect on cross-price elasticity, as an indirect effect of gas price increases, is undeniable). But I look at the change at vehicle miles traveled and I'm not convinced the shift away from gas is very large. And, I am convinced that what shift we are seeing is at least in part, as mentioned previously, an extremely short-run psychological shock to people's behavior as prices go past $4 for the first time.

In evidence of this psychological shock (I mean an actual shock of awe, not an economic one) I point to DOT data that shows that VMT fell by 4% March 07 to March 08, the first time prices shot past the psychologically important $4 in many major markets. But the April 07 to April 08 change was only 1.8%, which suggests to me (not being an expert on that particular data set) that people are already starting to get used to the prices - and absorbing it back to their more typical behavior. I'll say it again: with gas prices up almost 50% over last year, I don't think a 2% change in VMT is much at all - if anything it shows that even in the extreme short-run the psychological shock to the wallet doesn't last long (and that's ignoring the effects of the overall recession, and general inflation).

Beyond congestion and VMT, people surely are switching to hybrids etc. But I would argue again that this is only a part due to gasoline prices, and is much more influenced by the "coolness" of the green movement, the recession, general inflation, domestic car production problems, etc. Gas prices surely have an effect - a previous post here noted GM has altered its production line away from heavy trucks and SUV's due in part to rising gas prices - but one wonders if suppliers like GM will maintain this policy after the initial "shock" wears off. I don't think enough time has passed yet to answer that question.

So sure, case studies can be pointed to; dramatic interviews can be given by truckers; but overall, gas prices have a nominal effect on driving, congestion and pollution by extension. But, they do have a significant negative impact on the ability of people to lead their lives given that for many, gasoline is a necessity item. I think many economists have the causal roles backwards. Many want to force prices to rise thereby (slowly) changing behavior (some like Mankiw think behavior will change hard and fast). I think we should spend that time and energy letting market prices for gas prevail (they will rise on their own more gradually) and invest heavily in alternative transportation and energy etc. Let's get the infrastructure in place first so that people have alternative options before we start making it even harder for the average Joe to live.

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