On the elasticity of the demand for oil

Playing advocatus diaboli once again:

the price of oil rose fivefold in a relatively short period of time without much helping, a gradual increase in carbon taxes (in a Hotelling model) can lead to more extraction today thus worsening the problem, and if the rich countries massively cut their carbon consumption the prices of coal and oil would plummet and the incentive for someone to buy and smoke the stuff will be all that much stronger.

So says Tyler Cowen. Now, the argument seems plausible at first BUT if the demand curve for oil is fairly inelastic as the non-existent change due to rising prices seems to indicate then this argument raises at least some questions. If Western countries cut their consumption, a large part would basically just vanish – and as Mr Cowen himself says, not much would change in terms of demand (because, again demand is fairly inelastic). Shouldn’t the demand curve stay pretty much the same but move to the left because a large part is gone now that Western countries are no longer part of it?

Obviously, emerging economies are probably not as capable of paying a higher price as Western countries are – but seeing how they already make up a large (and ever growing) part of demand, I’m not sure how well that holds up. If demand is inelastic, than it should still be inelastic when it goes back down to $20 – minus the part that was demanded by Western countries. Unless, of course, it goes down even further and the demand curve looks different there. Or, emerging countries would somehow buy a LOT more than they already are and were back when prices were lower. And I’m just not entirely convinced of that – if we’re inelastic moving up, why should we suddenly be elastic when moving down the curve?

Sure, the demand structure would change and it’s certainly something worth considering but from the position of the devil’s advocate, it’s certainly a question worth asking. I’m sure there may be an answer out there to this question so I’d be more than happy to see it…


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