Working Paper

Heterogeneity in the Pass-Through from Oil to Gasoline Prices: A New Instrument for Estimating the Price Elasticity of Gasoline Demand

Abstract: We propose a new instrument for estimating the price elasticity of gasoline demand that exploits systematic differences across U.S. states in the pass-through of oil price shocks to retail gasoline prices. We show that these differences are primarily driven by the cost of producing and distributing gasoline, which varies with states’ access to oil and gasoline transportation infrastructure, refinery technology and environmental regulations, creating cross-sectional gasoline price shocks in response to an aggregate oil price shock. Time-varying estimates do not support the view that the gasoline demand elasticity has declined in absolute value to near zero since the 1980s. The elasticity was stable near -0.3 until the end of 2014. It rose to about -0.2 in 2015-16, but has remained stable since 2016. Gasoline demand is more responsive in states with lower personal income, higher unemployment rates and lower urban population shares. There is no evidence for an asymmetry in the elasticity with respect to positive and negative gasoline price shocks. We illustrate how these elasticity estimates inform the recent policy debate about the impact of gasoline tax holidays on consumers’ discretionary income, about the demand destruction from the spike in gasoline prices after the invasion of Ukraine and about the impact of rising gasoline prices on carbon emissions.

Keywords: price elasticity; gasoline; demand; Pass-through; taxes; identification; instrumental variables; Cross-sectional;

JEL Classification: D12; Q41;

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Bibliographic Information

Provider: Federal Reserve Bank of Dallas

Part of Series: Working Papers

Publication Date: 2023-01-06

Number: 2301