Friday, April 12, 2013

Elasticity of demand

A fascinating article in today's Wall Street Journal was pointed out to me by Prof. Rhoads. It's posted under "blog readings" in Blackboard.

We think of gasoline as an inelastically demanded good, meaning that we will consume about the same amount regardless of the price. In Venezuela, though, where they produce a lot of oil, gasoline is cheap because the government keeps prices low. One taxi driver pays more for a small cup of coffee than it costs to fill his tank: a gallon goes for between 2-6 cents. Since gas is so cheap, they use a lot more than do neighboring countries: about 5-6 times as much per person. If Venezuela were to sell that gasoline abroad, they could have instead about $11 billion per year, about three times as much money as they spent on health care last year and twice as much as they spent on education. Can you say, "Opportunity costs"?!

While that's good for the poor, who get access to something they probably couldn't afford, it's even better news for the middle and upper classes, who are more likely to have cars and much more likely to have bigger cars. It will be difficult to wean the country off of that cheap gas some day: when they tried once a few years ago, the price of riding the bus increased so much that there was a violent backlash, and hundreds of people died when the military fired on protesting civilians. Yet another example of subsidies causing huge externalities....

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