Finance & economics
Free exchange: Everyone has a price
Economists have changed their mind
High energy costs really due reduce use
Across Europe, two questions will set the political weather this winter.
How high will my energy prices go?
And what will the government do to protect me?
Attempting to shelter from the gathering storm, French and Spanish politicians, among others, have already capped or otherwise lowered gas and electricity prices.
With wholesale gas futures for early 2023 still climbing—up to more than ?300 ($299) per MWh, from less than ?30 last summer—and Europe’s economic indicators blinking red, more will follow suit.
That prospect is enough to drive economists to despair.
Politicians want to protect voters from big bills, but also need to cut energy use, so as to avoid blackouts and reduce Russia’s oil-and-gas revenues.
Price caps help voters, but do so inefficiently and reduce the incentive to cut energy use.
Until recently, however, economists would have said that their impact on fuel consumption was minor and their impact on gas consumption uncertain.
A body of research had found that consumers were largely unresponsive to higher petrol prices: they need to drive to work, and will do so even if expensive.
In this analysis, capping prices would not make a huge difference to energy consumption.
Yet a new batch of studies have overturned the conventional view, suggesting prices really do matter.
The difference reflects a change in research methods.
The earlier generation of studies analysed aggregate data, such as weekly sales and prices in a region, not demand from individual consumers or even driving patterns.
This is a problem because crucial information gets lost when aggregating data.
A mild increase in the weekly average price could hide a drop at the start of the week.
If that drop encourages more demand, an aggregate analysis might find that a higher price leads to more consumption, not less.
And prices at the pump are not set in isolation.
They respond to demand, making the price-demand relationship two-way.
Disentangling this is tricky.
More recent research analysing micro data has produced striking results.
To assess how consumers react to higher petrol prices, Laurence Levin of Visa, a payments firm, and co-authors looked at daily card transactions from 243 American cities in the late 2000s.
They found a sizeable response.
For a 10% rise in petrol prices, consumption fell by about 3%.
They also showed that, if they had used aggregate data, they would have concluded there had been a much smaller drop.
Christopher Knittel of the Massachusetts Institute of Technology and Shinsuke Tanaka of Tufts University used even more granular data, looking at a Japanese fuel-economy app, and found similar results with one extra detail: drivers not only responded to higher prices by driving less, they also drove more carefully to save fuel.