

By Jerry Taylor and Peter Van Doren
This article appeared in Investor’s Business Daily on May 25, 2007.
Ask a free marketeer what government should do about rising gasoline prices and the usual reply is “nothing,” because “high prices provide incentives to conserve and for companies to deliver new supplies.” But as gas prices near all-time highs, consumers are hardly flinching.

Sure, they’ll shake their fists at the oil companies if asked. But gasoline consumption is actually higher today (by 1%) than it was last year even though pump prices increased by 15% over the same period.

It seems that sellers can increase prices without harming sales a whit. A new study by energy economists at the University of California at Berkeley finds that from 2001 to 2006, a 10% increase in fuel prices typically reduced consumption by only between 0.3% and 0.8%.

End Of Innocence

In the mid- to late-1970s, on the other hand, a 10% increase in fuel prices would cut gasoline consumption 2% to 3%. Why the change? American motorists are much wealthier today than they were in the past, so price increases induce less conservation than they once did.

For instance, if we adjust gasoline prices in 1949 — 27 cents a gallon — for inflation, it works out to $1.90 per gallon in today’s terms. And if we adjust for changes in mean disposable income, we find that gasoline prices would have to be $6.68 per gallon before they took the same bite out of our wallets.

In 1962 — a year writ large in popular imagination (thanks to “American Graffiti”) as the quintessential year of muscle cars and cheap gas — gasoline prices averaged 31 cents per gallon. But changes in disposable income suggest that prices would have to be $4.48 to inflict the same degree of economic pain today as then.

The public likewise thinks of 1972 as our last year of energy innocence prior to the rise of OPEC and the onset of shortage. Well, fuel prices in 1972 averaged 36 cents a gallon, a hefty $2.77 a gallon in today’s terms once we adjust for inflation and changes in disposable income.

Golden ’90s

Today’s fuel prices are often compared to 1981, the year in which gasoline prices were highest after adjusting for inflation. Prices for unleaded gasoline averaged $1.38 per gallon then, or $2.70 in today’s terms. But prices would have to be $4.49 today to have the same impact. The Real Price of Gasoline So why all the vein-popping anger? Because few people do these sorts of calculations in their heads or note changes in the buying power of a dollar or increased family wealth. And median disposable income hasn’t risen as much as mean disposable income, which means that prices really are higher for the poor today than they often were in the past.

For instance, adjusting real 1962 prices by median disposable income yields an equivalent price today of $2.78 a gallon; 1972 to $1.76 a gallon, and 1981 to $3.33 a gallon.

And let’s not forget that the cheapest pump prices in recorded history are still fresh in our minds. Subconsciously, we still bench-mark today’s prices by the anomalously low prices we paid in the 1990s.

Though politicians often condition us to think that all price increases are the products of corporate conspiracy, there’s no evidence of corporate price-fixing or collusion over the past 40 years. (Though the belief that this sort of thing goes on is as stubbornly held as the belief that aliens periodically visit remote parts of the United States for medical testing.)

The main reason, however, is the frustration associated with being held economically hostage to a commodity we can’t do without. If tomato prices go up, we can buy fewer tomatoes without sacrificing much. But when gasoline prices go up, few people are willing to start car-pooling to work or bike-riding to the grocery store.

In spite of the sticker shock, we don’t need politicians to come to our rescue. The Bureau of Economic Analysis reveals that the percentage of personal income that Americans spend on driving has been relatively constant over time: about 10.2% since 1960.

Who’s In Control?

The percentage of our personal income that we spend on fuel, however, has fluctuated a great deal more than that. When pump prices go up, people adjust by spending less on other aspects of driving, like new car purchases, automotive maintenance, new paint jobs and stereos. Over time, they’ll buy more fuel-efficient cars to reduce the amount of gasoline they need to buy.

In short, consumers — not oil companies — exercise control over how much they spend to get from here to there. Keep that in mind while doing likewise this Memorial Day weekend.

Jerry Taylor and Peter Van Doren are senior fellows at the Cato Institute. Van Doren is also editor of Regulation magazine.