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The Far-Reaching, Lasting Effects of Low Oil Prices

With SUV sales up, car sales down, and mileage driven up, the effects of lower gas prices could soon extend to land use, making suburban and exurban commuting more affordable. Economists have a term for these effects: demand response.
February 24, 2015, 6am PST | Irvin Dawid
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Josh Zumbrun, national economics correspondent for The Wall Street Journal, explains the far-reaching effects of plunging oil prices, though they may not be immediately felt. Key to his findings is this three-part image showing:

  • Estimated increase in demand
  • U.S. vehicle sales (split between leaner cars and less-efficient SUVs and trucks)
  • Mileage driven

Zumbrun describes two basic economic terms that help explain the energy/economic forces just beginning to take hold now, starting with "demand response."

Oil prices fell and stayed low in the 1980s and 1990s, gradually reducing worries about energy consumption. That fueled a boom in exurban housing developments and left industries less cautious about their fuel use. Economists call this a “demand response.” The changes took years

The last sentence is key—the changes become more visible over years, as Zumbrun explains in his description of the second economic term, elasticity. He starts with elasticity when oil prices increase.

When oil prices were rising in 2011, the International Monetary Fund (IMF) estimated that every 10 percent increase in the price of oil quickly reduces demand for oil by about 0.2%," he writes. Consumers adapt through vehicle selection, commute patterns and modes, housing choices. The effect is rather startling on transit ridership according to a 2011 study.

If the (oil price) increase proves lasting, the change grows to about 0.7 percent. Economists consider it a clear case of a product whose demand is "inelastic" in the short run—that is, changes relatively little in response to price—but “elastic” in the long run, meaning it can eventually change quite a lot.

What's happening now, of course, is the reverse, but rather than a 10 percent decrease—it's 50 percent. "All told, demand for oil could rise by 1.25 percent in developed countries in the short run and 4.7 percent if the price stays so low," writes Zumbrun.

For a better understanding of the economic forces at work due to plummeting oil prices and their consequences that may take some time to materialize, watch The Wall Street Journal Video. Moderator Paul Vigna asks Zumbrun all the right questions.

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Published on Sunday, February 22, 2015 in The Wall Street Journal - The Outlook
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