Estimating the elasticities of gasoline demand: an instrumental variable approach

ABSTRACT

This article uses a new identification strategy to estimate the demand for gasoline. I show that the monthly gasoline price is endogenous to gasoline demand at the state level, and that gasoline tax and domestic oil first purchasing price together are strong and valid instruments to correct for the endogeneity bias. In addition to estimating the price elasticity, this article also provides an estimate of the income elasticity. These updated estimates are critical factors in evaluating the environmental effect of gasoline tax and forecasting gasoline consumption.

KEYWORDS:

• Gasoline demand
• price elasticity
• income elasticity
• instrumental variable

JEL CLASSIFICATION:

• C33
• Q41

Disclosure statement

No potential conflict of interest was reported by the author.

Notes

¹ Using gasoline tax as instrument in an FD model, Davis and Kilian (2011) find a surprisingly large price elasticity of −1.14. When reducing the sample to include nominal tax increases only, the price elasticity drops to −0.46, but is still significantly larger than estimates in other studies.

² The residuals of the FD regression have an autocorrelation of −0.156.