EMF OP 50: The Asymmetric Effects of Changes in Price and Income on Energy and Oil Demand

This paper estimates the effects onenergy and oil demand of changes in income and oil prices, for 96 ofthe world’s largest countries, in per-capita terms. We examine threeimportant issues: the asymmetric effects on demand of increases anddecreases in oil prices; the asymmetric effects on demand of increasesand decreases in income; and the different speeds of demand adjustmentto changes in price and in income. Its main conclusions are thefollowing: (1) OECD demand responds much more to increases in oilprices than to decreases; ignoring this asymmetric price response willbias downward the estimated response to income changes; (2) demand’sresponse to income decreases in many non-OECD countries is notnecessarily symmetric to its response to income increases; ignoringthis asymmetric income response will bias the estimated response toincome changes; (3) the speed of demand adjustment is faster to changesin income than to changes in price; ignoring this difference will biasupward the estimate response to income changes. Using correctlyspecified equations for energy and oil demand, the long-run response indemand for income growth is about 1.0 for Non-OECD Oil Exporters,Income Growers, and perhaps all Non-OECD countries, and about 0.55 forOECD countries. These estimates for developing countries aresignificantly higher than current estimates used by the US Departmentof Energy. Our estimates for the OECD countries are also higher thanthose estimated recently by Schmalensee-Stoker-Judosn (1998) andHoltz-Eakin and Selden (1995), who ignore the (asymmetric) effects ofprices on demand. Higher responses to income change, of course, willincrease projections of energy and oil demand, and of carbon dioxideemissions.