Working from home and the price elasticity of demand for petrol

The Dangerous Economist (Cyril Morong) had a great post last month on how working from home has affected the price elasticity of demand for petrol (and linking to this (paywalled) Wall Street Journal article). Cyril did an excellent job of outlining factors associated with more elastic demand, but given that my ECONS101 class covered elasticities this week, I thought it might be useful to reiterate some of his points, and add a few of my own.

The price elasticity of demand is the responsiveness of quantity demanded to a change in price. The more that consumers respond to a price change, the more elastic the demand for the good or service is. There are a number of factors that together are the main determinants of the price elasticity of demand. The determinants that I discuss with my ECONS101 class are:

1. The availability of (close) substitutes - having more (or closer) substitutes leads to more elastic demand;
2. The proportion of income spent on the good - if consumers spend a higher proportion of their income on the good, they are more sensitive to its price (more elastic demand);
3. The significance of price in the total cost to the consumer - if the price is a more significant component of the total cost of obtaining the good, then consumers will be more sensitive to the price (more elastic demand);
4. The definition of the market - a narrower definition of the market means that there will be more close substitutes (more elastic demand);
5. Time horizons - consumers who must make their decision quickly are less sensitive to the price (less elastic demand); and if you consider the price change over a longer time period, it will be more elastic (since consumers will have more time to find alternatives); and
6. Normal goods - ceteris paribus, normal goods will have more elastic demand than inferior goods (due to the income and substitution effects working in the same direction for normal goods, but in opposite directions for inferior goods - for a bit more explanation of those effects, see this post).

The first two of those six determinants tend to be the most important.

Now, petrol tends to have relatively inelastic demand, at least in the short run. Consumers don't change their driving habits by much when the price of petrol changes. Maybe they make fewer trips than they otherwise would have, and sometimes walk or bike or take public transport instead. But there are many trips that cannot be replaced by walking, biking, or public transport. In the long run, perhaps consumers could switch to electric vehicles, or move closer to work or school. The adjustment to the amount of petrol demanded is larger in the long run (more elastic).

How does working from home change this picture? When workers can work from home instead of driving into the office, this makes available a new substitute for driving. Working from home is relatively cheaper than driving, so many workers would prefer to work from home, if they can. That makes demand for petrol more elastic. The change in elasticity will be greatest for workers where working from home is a closer substitute to working in the office. That will include workers who don't have to drive towards work for other reasons, such as dropping kids off at school, grocery shopping on the way home, etc.

The current high price of petrol (as a result of the war in Ukraine, and unrelated to working from home (as far as we know)), has probably reinforced the increase in the price elasticity of demand. If petrol is now taking up a higher proportion of household income, demand will tend to be more elastic for that reason as well.

Combining those effects, demand for petrol is more elastic now than it was before the pandemic led to a large increase in working from home.