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Working Paper

The Price-Induced Energy Trap

Exploring the Impacts of Transportation Expenditures on the American Economy
  • By John A. "Skip" Laitner, American Council for an Energy Efficient Economy
October 2011 |

Even though the U.S. economy grows at an anemic rate of perhaps 1.5 percent and 1.9 percent (or less) in this year and next, the world economy is likely to expand by well over 3 percent in that same two-year period. The world demand for oil is expected to increase, concurrently, by about 1.5 percent annually. The most recent projections by the U.S. Energy Information Administration (EIA 2011a) suggest that – absent major disruptions – the growing demand for energy worldwide will continue to push oil prices up in a slow but steady movement.  Absent dramatic changes in U.S. energy policy, consumers are likely to continue to pay high and volatile prices.

Despite an anticipated 1.8 percent decline this year in gasoline consumption, for example, the overall expenditures for gasoline will increase 25 percent, rising from $391 billion dollars in 2010 to $489 billion dollars in 2011. Both the size of the U.S. gasoline bill, and its dependence on global events, impact the lives and well-being of individuals, families, and households – especially those from the middle and lower income levels. And as consumers’ incomes, already shrinking in the after-effects of the recession, continue to be absorbed by high fuel costs, gasoline is becoming a drag on the economy.

How will U.S. policy makers navigate the future? For decades price has been the focus of policy-maker’s attention. Policy-by-price has taken three approaches. First, policymakers have tried to keep prices low through subsidies for ethanol and biofuels, increased domestic oil production and an active foreign policy toward oil suppliers, while letting “the market” (i.e.,rising prices), tell consumers when to change their habits or autos. Another approach has added CAFE standards for automobiles to the mix as a way of reducing demand in the fleet overall, while ensuring that consumers are steered towards more efficient vehicles in response to those prices.  A third approach wishes to make gasoline price more truly reflect its external costs through taxes, carbon fees, and highway use fees. All approaches emphasize the role of “the price signal” in providing incentives that encourage a smarter use of energy. All strains of policy assume that consumers can and do respond to higher prices by reducing demand in an economically rational fashion.

However, a growing number of papers, and recent historical evidence, suggest that U.S. consumers respond to rising energy prices in a limited way (see, for example, Hughes, Knittel, and Sperling 2006; and Turrentine and Kurani 2007).As oil prices have risen, consumer response has been limited, providing a real-world simulation of the efficacy of price as a signal. Perhaps consumers cannot change their automobiles, or their commutes, or their habits quickly enough. If that is the case, then relying on price as a way to reduce oil consumption, or create “rational” allocations of resources, may be flawed. Furthermore, it’s possible that a price-based policy itself may be paradoxically increasing, or at least freezing, energy consumption patterns and enabling the gas pump to capture more of U.S. workers’ disposable income.

Better understanding why very high gasoline prices do not lead to dramatic reductions in gasoline consumption could lead to policies that more quickly, and less painfully, reduce gasoline demand and consumer spending. Data from the Bureau of Labor Statistics suggest that what households spend on transportation services, including expenses and payments for the car, is more than what they  spend on both health care and taxes combined (Consumer Expenditure Survey 2010). Taking specific actions to reduce the cost of transportation, by improving the range of lower-cost choices, or increasing consumers’ understanding of those choices, could allow households to act in an economically rational manner to reduce gasoline spending and increase their discretionary spending elsewhere in the economy.

At a slightly higher level, there is also reason to wonder whether persistent inability to make rational reductions in energy use is among those things which constrain overall U.S. economic activity.  In other words, higher oil prices not only increase the cost of energy services, but the on-going dependence on the inefficient use of oil (and other conventional energy resources) is likely to weaken the nation’s improvement in per capita income.  We are confronted with higher energy prices that increase consumer and business costs. At the same time, the lack of income or investment to improve our transportation system efficiencies locks us into a pattern that weakens the economy and reduces the prospect for future gains in income. Much research needs to be done to probe these larger questions and puzzle through this conundrum.

This paper, using widely-available economic data,is a first step at unraveling how current policies and consumers “lock-in” these costly spending patterns.  In the sections that follow, we first will review emerging patterns of consumer income and spending to place energy and transportation expenditures into context. Next we will analyze existing data to evaluate the responsiveness of consumers and businesses to changes in incomes, prices and policies as they all impact energy consumption. Following that we will look at how consumer responses to energy prices appear to have changed over time. Then we will look at data on how different consumer income groups respond to energy prices. At that point we will examine how continued inefficiency constrains our economy.  We will then conclude by generalizing about the policy insights--and much bigger questions--that emerge from the data.

The full report is available in PDF form.

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