The Irreversible Demand Effects of High Oil Prices. Motor Fuels in France, Germany & the UK

The majority of aggregate demand studies, whether concerned with energy or other goods, are based on the notion of a stable long-run demand function, which implies the existence of a unique equilibrium demand for any given relative price and income level. Given this static relationship, the effects of any price (or income) change will, by assumption, be totally negated as price (or income) returns to its initial level, so that demand is completely reversible. In some cases technical change may be introduced, which serves to change the equilibrium demand relationship over time, but it is generally assumed to be of an exogenous nature, unrelated to the actual price development. Although such technical progress surely exists, there is good reason to believe that prices, themselves, provide a motive force in the development of new technologies, so that some component of technical change is certainly price induced. Clearly, in the case of energy consumption – whether in industrial processes, transport or space heating – increasing efficiency has been attained over the past fifteen years chiefly in response to high energy prices. Since some of these energy-saving technologies will remain economically optimal despite falling prices, there is good reason to believe that the era of high energy prices will have a lasting, dampening effect on demand. If this is the case, reversible demand functions or specifications which only allow for exogenous technical change
will not provide an adequate description of energy demand. Estimates of elasticities and forecasts based on such models could therefore be misleading.

By: J. M Dargay

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