This chapter takes the form of a brief note to highlight a specific issue of direct and central relevance to studies of energy elasticities, and the use of elasticity estimates for demand projections and policy analysis. The chapter1 does not seek to develop estimates of elasticities or to review in detail methodological issues. Rather it addresses an underlying issue in the estimation and use of elasticities, one which in the author's view is of primary importance and which will come to be seen as such in future developments in the field.
This issue concerns asymmetries in response to price changes—asymmetric elasticities—and the directly associated issue of induced technology development.2 It is important because allowing for this possibility can greatly alter econometric estimates of elasticities, and hence alter energy demand projections and our overall understanding of responses to energy price changes. Indeed, the issue carries deeper implications of relevance to energy and environmental policy. In economic terms the proposition is extremely simple, namely that the response to price rises is not matched by an equal response to equivalent price falls. More specifically, it is that the reduction in energy demand following a price rise can be substantially greater than the subsequent rise in demand if and when prices revert towards former levels. Thus, not only are current and recent prices important, but the history of prices is important. This simple proposition is one which many non-economists might take as inherently plausible. Nevertheless, in economic terms it is a departure from the norm, and challenges the assumption that the magnitude of demand responses to a price change is independent of the direction of the price change.
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