Economic Impact of Persistent High Essay

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The long-run price elasticity of demand for gasoline is stronger at 0.7 (Ibid). This implies that in the long-run, given higher gas prices, consumers will adjust their consumption habits. One example is that consumers will purchase more fuel efficient vehicles, thereby lowering their consumption level. Some consumers may switch to public transit. Young adults entering the workforce may eschew car ownership altogether in favor of other modes of transport. In the long run, businesses will also seek out alternatives for plastics, because those will rise in price as well.

The price elasticity of demand for oil may also exist on a curve. This means that the higher the price rises, the greater the price elasticity of demand will be. It may also change over time, as more consumers and businesses come to the realization that oil prices will not drop at any point in the future. At this point, there will be a profound shift in consumption patterns away from oil. It may get to the point where oil demand falls so far that its price begins to stabilize (albeit at a very high level).

Substitutes

Alternative energy sources are substitutes for oil. There are a wide range of these including nuclear, solar, wind, electric cars, coal, and any other potential energy source. The demand for these will be affected by the price of oil, and this is known as a cross-price elasticity. The cross-price elasticity of any alternative energy source will depend on the availability of that source and its uses. So for example solar energy might have a high cross price elasticity for home usage in the Southwest, because it is capable of doing the job and is in plentiful supply. Hydroelectric power would have a lower cross-price elasticity of demand in the Southwest because rivers are in short supply in some of those states, meaning that supply is low.

In general, alternative energy sources will see an increase in demand if the price of oil continues to rise. For a time, the consumer tendency will be to make direct substitutes, much like they do in the short run (i.

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e. taking the bus instead of driving). In the long run, however, expect consumption patterns to change. For example, instead of taking the bus the consumer chooses to work close to home. In the very long run, city planners build their cities on a model of having people live and work in the same neighborhood (as what happened before cars). Thus over time, demand to alternative fuels would first rise and then fall as we shift the structure of our lives to de-emphasize energy consumption altogether.

Diagram

The following diagram compares oil demand vs. demand for alternatives as oil price rise.

Conclusion

As the price of oil rises, demand for oil is expected to fall. Users will at first seek substitutes, and then over time will simply replace the consumption of oil altogether as the price becomes too high. Eventually, the only demand for oil will come from those users for whom there are no substitutes. Alternative energy sources are the first substitutes and in general the demand for alternative energy will rise as the price of oil rises. Over time, however, consumption patterns may adjust to overall lower demand for energy, which would bring the demand for alternatives down. The impact of higher oil prices will also change as the price rises, and the impact on alternatives will depend on the demand and supply conditions for each alternative in a given market.

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