Elasticities in the Short and Long Term

Via Dessler and Revkin, an interesting interview with economist Gary Yohe that gets to the heart of the puzzle about gasoline consumption this year. Gas prices soared over the summer, but consumption dropped only a bit (on the order of 3-5 percent year-over-year). The question posed by critics of a carbon tax as a greenhouse gas reduction measure – what does this suggest about the size of the tax required to get serious reductions? If doubling the price of gas doesn’t get us very far (and most advocates think we’ve got to go farther than 5 percent), does that mean a price increase in the form of a gas tax won’t work? If you look at this year’s data, you might be tempted to come to the conclusion that the gas tax would have to be enormous.

The answer, as Yohe explains, lies in the difference between short and longer term elasticities. In the short run, there’s not much you can do. In the longer term, a consistent signal that prices will be higher (which government can send in the form of a tax in a way the market on its own will not) makes me more likely not to buy that Hummer I’ve been so badly wanting. Here’s Yohe:

The price bounces around and that adds a little bit of uncertainty, potentially a lot of uncertainty… A tax, on the other hand, sends a very strong price signal that’s unambiguous and not clouded with a lot of noise, so that people can actually understand what carbon will cost them and how the price of carbon will increase persistently and predictably over time.