The demand curve slopes downwards – New Zealand petrol edition

Stuff mentions a survey done by Research New Zealand on petrol prices and household consumption of petrol. In the survey they found a number of results that seem to follow the basic idea of a demand curve.

From the article the results were:

  1. 32% of people said they consumed less fuel since the price rose (I am assuming that the remaining 68% would consume the same amount, not more 😉 )
  2. Half of consumers said they would consume less fuel if the price went over $2 a litre
  3. More woman are driving less than men (35% to 29%)
  4. 70% of those that earn over $70k have not change petrol consumption
  5. If petrol crossed $2, 64% of those earning under $40k would consume less petrol compared to 49% of those that earn over $70k.

It is entirely possible that these facts were cherry-picked by the NZPA article, however lets try to understand them.

Number one simply tells us that the demand curve slopes downward over the spectrum of prices we have already experienced. In other words – in the price range we have faced the quantity demanded has fallen as prices have risen. Awesome.

People are stating that they would consume even less if the price went higher. Of course we can’t completely trust people to do what they say, so we can’t state for certainty that the demand curve for petrol will continue to slope downwards up to $2. However, this at least gives us a feeling that it might.

In the third point it states that women are more responsive to the price than men. Well on average, female income is below male income, implying that they are likely to have more income elastic demand for goods – as petrol is a normal good, and accounts for a large proportion of total spending in some cases, then a discrepancy between male and female consumption makes sense. Also, as a greater proportion of women are secondary earners, at the margin we are likely to see women value fuel consumption (as a means of getting to work and receiving a wage) at a lower rate than men relative to other goods.

Putting these together, we are saying that both the income and substitution effects imply that women should be more responsive to a change in the price of petrol than men – and that is what we have.

The fourth point tells us that people who earn a lot of money are slightly less likely to cut back on driving, while the fifth point states that respondents answer survey questions in a way that would make this gap widen.

This is an interesting result. We might expect the rich to cut consumption less, as the income effect would be smaller (as petrol takes up a smaller amount of their budget) and, if someone on a higher income received the same value from things as someone on a lower income then there would be a lower opportunity cost associated with keeping the level of petrol consumption constant (as people have diminishing marginal utility).

However, if the petrol is used to go to work, and most people on a higher income get higher wages, then the wage sacrifice associated with cutting petrol consumption would be greater – the overall utility sacrifice would be ambiguous. Furthermore, as petrol is a normal good consumption will increase in income – some of this consumption may be discretionary rather than necessary – such as going for a sunday drive. Discretionary fuel consumption is likely to react to increases in petrol prices – which is why 30% of those with incomes over $70k did actually cut their petrol consumption (only slightly below the 32% cut for the whole survey).

Overall, this survey seems to support some basic economic proposition which is good. I am sure I minced this post somewhere along the line, I don’t have too much time to write at the moment – feel free to correct me in the comments.

  • CPW

    I wish these surveys made at least some reference to the hard data available on the topic at hand. Although I’m sure that demand for petrol is normal if fairly inelastic, a quick look at the retail series suggests that fuel volumes have actually been growing very strongly over the last five years despite the strong price increases. Which more or less refutes the article’s claim that rising petrol costs are making us change our driving habits.

    Anecdotally public transport usage is growing up, which I’m not sure how to reconcile with the petrol series. Everyone is just consuming way more transportation?

  • “Which more or less refutes the article’s claim that rising petrol costs are making us change our driving habits”

    It is true that the series has been growing strongly, however I’m not sure that this refutes the surveys claim. After all, petrol is a normal good and we have had significant increases in income and wealth over this period. Furthermore, there have been demographic shifts – with population growth coming in fairly strongly (through migration) and wasn’t there like a bunch of little bitters getting old enough to drive now.

    “Everyone is just consuming way more transportation?”

    This may be true, maybe people are happier to consume discretionary transport now eg going for a drive somewhere for no reason.

    However, I agree that this specific detail feels a bit dodgy – it would be interesting to have a few more numbers to look at.

  • Yes – everyone is consuming more transportation, if we mean everyone = NZ population as a whole.

    I have been looking at fuel demand in NZ too from a different perspective and agree with what the study is saying.

    There are a whole bunch of reasons why we have been consuming more “transportation” – including spending on petrol. This represents an outward shift of the demand curve. Immigration is one reason as is “natural” population growth and domestic migration. Higher incomes and increased job security are also playing their part.

    A quick look at the 1995-price retail fuel sales data shows that volumes have come back to 2004 levels after spiking in 2005. The upswing is consistent with the strong economic growth we enjoyed while the downturn may well be the effect of the higher international price of petrol kicking in. This does not mean that people are not changing their driving habits.

    I do believe that demand for petrol is fairly inelastic – it is after all a “grudge purchase”. I would characterise the behaviour in the market thus:

    Growing domestic demand for petrol has pushed the demand curve to the right. this resulted in purchases of fuel going up 12% from the 1995-2003 average sales. The rising cost of oil internationally saw a dramatic shift in the supply curve upwards, reuslting in a reduction in purchases as prices rise. Of course, these effects were going on at the same time but I break them down like this to make it clearer what the individual influences are.