By now you've certainly noticed that gasoline prices are considerably lower than they have been in quite some time. In fact, national average gasoline prices are over $1 per gallon lower today than they were this time last year thanks to the global oversupply of petroleum. The downward trend looks likely to continue in the short term and should result in you spending less on gasoline in 2015 than at any point in the previous 11 years, according to the U.S. Energy Information Administration.
Spending 31% less to fill your tank is hardly something to complain about, but don't assume falling gasoline prices will result in your fellow Americans driving any farther in 2015. Why not? It all has to do with the basic economic principle of elasticity. As we sit back and count our savings, let's use the current relief at the pump to refresh on a little Economics 101.
Is gasoline an elastic or inelastic product?
Economists measure price elasticity by determining how demand for a product is affected by its price. Demand for an elastic product changes with its price (higher prices curb demand, lower prices spur demand), while demand and price are not strongly correlated for an inelastic product. For instance, nails are an inelastic product. If a carpenter needs 10,000 nails to frame a new house, then it doesn't matter if nails sell for $0.01 or $0.10 -- the same number of nails is required.
In this context, we can determine that gasoline is also an inelastic product. Cheaper gasoline won't change the distance of your commute to work or how efficiently you drive to pick up your kids from school. In other words, how you use the product is largely unaffected by its price. You might be more inclined to visit that friend who lives a few hours away, but it won't make a big change in the grand scheme of things.
Historical data back up the conclusion that gasoline is an inelastic product. From 1991 to 2014, the real price of gasoline increased 24%, but the miles driven by Americans increased by 48%. Even big, overnight increases and decreases in gasoline prices had almost no detectable impact on how far we drove. Put another way, automobile travel in the United States is inelastic.
Just how inelastic is gasoline? According to the EIA, gasoline prices would have to decrease 25% to 50% for automobile travel to increase 1%. That means gasoline prices could fall to $1 per gallon and only increase the number of miles driven this year by 3% compared to previous years.
What does affect how far America drives?
The factors driving automobile travel in the United States change with time. For instance, more people live in cities now than they did several decades ago. That has made gasoline more inelastic than it was in the 1980s, since urban residents tend to drive less than those in suburban and rural regions. Other factors affecting the elasticity of gasoline include the large number of retired baby boomers, who typically drive less than working individuals, and rising fuel economy of the nation's automobile fleet.
Elasticity and inelasticity are relatively simple concepts, but can still predict why the millions of registered drivers in the United States won't be piling miles onto their odometers in 2015. So the next time you stop to fill up your tank and smile at the low price of gasoline, perhaps you'll take a moment to explain a basic economics principle to your child. And if you're thinking about what to do with your savings in the new year, then hopefully you'll consider taking control of the future of your personal finances by investing in stocks -- no financial planner required. Not sure where to begin? The Motley Fool has you covered with its 13 Steps to Investing.
