Gas Prices: Is the Pain Real?

Photograph by Landov

Gas prices have jumped by 30¢ a gallon, to an average of $3.73, over the past month. Where I live, the increase seems even higher. It’s tough to get a gallon for less than $4, and filling up costs at least $50. I’ll admit that it hurts, and I don’t even drive much. (I have the good fortune of being able to take a train to work.)

President Obama and his would-be Republican rivals have all made gas prices a big part of their message, and some pundits are saying the cost of gas could derail the recovery. How much do gas prices really affect the economy? The short answer is: quite a bit, but probably not as much as we think.

To get a better sense of the real economic cost of rising gas prices, I called George Loewenstein and Russell Golman, behavioral economists at Carnegie Mellon University in Pittsburgh. They were gracious enough to take time out from their lunch of curried chicken salad (Golman) and mac-n-cheese (Loewenstein) to talk about why changes in gas prices seem so much more painful than rising costs of many other goods.

“People tend to respond to things in a comparative fashion,” Loewenstein tells me. “The salient comparison for gas prices is what they were in the recent past, not the real price compared historically.” Salient is economist-speak for “we notice it a lot.”  For most Americans, gas prices are really noticeable—they glare at us in three-foot-high letters on  suburban street corners. “What other prices do you see posted on billboards everywhere?” Golman asks. “Probably none.”

And think about the way we buy gas, with those pennies whipping by so fast. If we bought milk or hamburgers from a pump, as we do gas, we’d be a lot more aware of how much they cost. While gas prices are high, they’re not dramatically higher than at other historic peaks. We feel the difference more acutely.

With a gallon quite possibly headed over $4 in the next few weeks, the increase just might spur many of us to put off driving to Florida for spring break. But come summer, if prices stay around $4 and don’t, say, rise to $5, most of us will become numb to the pain of $4-a-gallon gas and pack up the SUV for that trip to the Cape. “People get used to what things cost,” Loewenstein says. “If prices don’t rise, they’ll recede from people’s consciousness.”

At the same time, the economists tell me, many drivers don’t have a full understanding of the long-term cost of gas, just as they don’t really know how much they’re spending on cigarettes or Starbucks. While more car buyers take gas mileage into consideration these days, few focus on how much they’ll end up spending on gas every year. “People don’t really think about how many gallons of gas they’re paying for over the life of the car,” Golman says.

So what is the economic effect of higher gas prices? “Most of the driving people do is not discretionary,” Loewenstein says. “They can’t cut back.” For families living from paycheck to paycheck, gas money has to come out of other spending. “The economic impact is substantial because gas is a fairly big part of people’s budgets. Lower-income people especially are getting squeezed pretty horribly.”

Just how much? A recent Credit Suisse report says each penny increase in gas prices takes $1 billion out of the economy over the course of a year. So a 50¢ jump would mean $50 billion that’s not spent on other stuff. “If gas prices go up and people have to commute and can’t cut back, they have two choices—take on debt or cut back on something else,” Loewenstein says. Still, U.S. consumer spending last year was about $10.7 trillion. While $50 billion isn’t chump change, it’s not going to have a huge effect on the economy.

Longer-term, higher gas prices might even be a good thing, both economists tell me. If you get sticker shock every time you fill up, you’re more likely to swap the Highlander for a plug-in Prius or ditch the four-wheeled commute altogether. “There used to be a certain type of person who commutes by bike,” says Loewenstein, who gets to work via pedal power. In the past year, he says, “the range of people who are on two wheels has expanded considerably.” If enough people make similar changes, getting around by bike, train, bus, or their Nikes, it could cut our reliance on foreign fossil fuels and reduce global warming—all good things for society as a whole.

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