Alusaf Case Essay

1405 words - 6 pages

Estimating the Elasticity of Demand for Gasoline
Professor Pushan Dutt
The graph below shows the evolution of the price of oil (adjusted for inflation) since
1957. Note a couple of sharp jumps and collapses in the price of oil.
1.
2.
3.

1973: : 2.75 % of global production was withheld; Prices in nominal terms
jumped from $3.5 a barrel to $10 a barrel
1979: 5.68 % of global production withheld; Prices in nominal terms jumped
from $15 to $32 a barrel.
2007: Oil prices increase from $60 to reach a peak of $128, followed by a rapid
collapse

Why do we observe such sharp swings in oil prices? The answer lies in the elasticity of
demand and supply. For this exercise we will focus ...view middle of the document...

We will also assume
that the demand function is log-linear. The advantage of this specification is that all the
estimated coefficients are elasticities. For example, in the specification below β is the
price elasticity and γ is the income elasticity of gasoline. Please note that we add a
negative sign in the price elasticity formula so the price elasticity will be – β.
log Gt     log PGt   log Yt   log PNCt   log PUCt

Step 2: Collect Data
Variable
G
PG
Y

PNC
PUC
Inflation
Population

Source
U.S. Energy
Information
Administration
U.S. Bureau of
Labor Statistics
Federal
Reserve
Economic Data

Website
http://tonto.eia.doe.gov/dnav/pet/his
t/mgfupus1m.htm
http://data.bls.gov/cgibin/surveymost?ap
http://research.stlouisfed.org/fred2/s
eries/A229RX0#

U.S. Bureau of http://www.bls.gov/cpi/data.htm
Labor Statistics
U.S. Bureau of http://www.bls.gov/cpi/data.htm
Labor Statistics
U.S. Bureau of http://www.bls.gov/cpi/data.htm
Labor Statistics
http://research.stlouisfed.org/fred2/s
Federal
Reserve
eries/POP
Economic Data

Notes
Thousands of barrels;
multiply by 42 to
convert to gallons
Monthly retail price
of a gallon of gas
Real per capita
disposable income;
Monthly, seasonallyadjusted data
Monthly, seasonallyadjusted data
Monthly, seasonallyadjusted data
We need to adjust
prices and income for
inflation
We need population
to get per capita
gasoline consumption

Is that too much work? Since I am feeling generous and since duplication of effort should
be avoided, go to the class website and retrieve Excel file: gasolinedata.xls
The raw data sits in the “raw data” spread sheet. The data you will use sits in the
“adjusted data” sheet. Here the gasoline consumption is in gallons and the price of

gasoline is adjusted for inflation. Price of used cars and new cars are price indices so we
don’t need to adjust this.

Step 3: Seasonal Adjustment of Gasoline Consumption
The sheet Chart 1 plots the evolution of per capita gasoline consumption over time. Do
you discern any pattern in the data that may require additional variables in the regression?
Which months are the peaks and which months are the troughs? Does this seem
reasonable?
Given that there is a clear seasonal pattern in the data we need to adjust gasoline
consumption in the spreadsheet “adjusted data.” A simple way to do is to calculate a 12month moving average
 Click Data Analysis, and choose Moving Average
 Highlight column labeled G in the spreadsheet “adjusted data”
 Input 12 for 12-months in the Interval box.
 Select cell I2 as the place to output the moving average. This will create a variable
for seasonally adjusted gasoline consumption. Call it SG.
 Again, this is done in spreadsheet

Step 4: Basic Demand Function






Take the natural log of all the variables (base e not base 10; ln(x) in Excel). Put
them in a third spreadsheet. Call it “data for regression”. Name the...

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