Signal? What signal?

Message to the Coalition: people respond to incentives.

I was listening the other day to Tony Abbott claiming that the price elasticity of petrol is zero (Joshua Gans quotes the Coalition’s Greg Hunt making the same claim). It was perhaps the first time that I had heard a politician use the word ‘elasticity’, and it made me wonder whether Abbott was resorting to jargon because it would sound more outlandish to say ‘we don’t believe people buy less petrol when the price goes up’.

Anyhow, this struck me as the kind of issue that people have probably researched, and sure enough a quick search turned up a nice meta-analysis by Daniel Graham and Stephen Glaister. Here’s the key graph: [Link now broken]

As the authors conclude:

There are differences between the short- and long-run elasticities of fuel consumption with respect to price. Typically, short-term elasticities are in the region of -0.3 and long-term between -0.6 and -0.8. Therefore, it may be right to say that ”it won’t make much difference” or ”people will use their cars just the same”, but only in the short run. The evidence is clear – and remarkably consistent over a wide range of studies in many countries – that in the long run there is a significant response, albeit a less than proportionate one.

In other words, a 10% rise in petrol prices reduces petrol demand by 3% in the short-term, and by 6-8% in the long-term. (Although the study isn’t clear on this point, I’m guessing short term is <1 year, and long term is >1 year.)

Of course, these aren’t the first politicians to ignore economic evidence, but this seems to be an instance in which the evidence is simply overwhelming.

[Andrew Leigh]