## Tuesday, May 31, 2011

### Gas Rules Everything Around Me

Let me quickly explain what the chart below shows...

Since 1995 (the furthest back you can easily obtain real consumption by category), nominal gasoline purchases as a percent of personal consumption has increased by 44% (gasoline was 2.8% of all personal consumption, now it is 4.0%), while it has decreased by 33% in real terms (we now consume about 5% more gas in real terms, while overall consumption is up more than 58%).

In other words, we are spending a LOT more of our paychecks on gasoline, which in turn is becoming a much smaller portion of our real consumption. It would be rather interesting to know where the U.S. economy would be if all this consumption was freed for other goods / services (i.e. the benefit for the nation of investing in alternative energy).

Source: BEA

1. I'm really confused. Why would the fraction of our personal consumption of something change based on whether or not the measure was real or nominal? Whatever measure of inflation you use, it will affect the numerator (gas expenditures) and denominator (consumption) the same, cancelling out. Could you explain this a bit more?

2. Jonathan-

If inflation impacted all goods the same, you are correct. But inflation has not impacted gas the same as all other goods (price of gas has jumped 5-fold, while broader inflation is up 2-3% annualized over the long term).

Example:

Day 1: gas is 1/3 our purchases real and nominal

Gas = \$25
All else = \$50
Total = \$75

Day 2: gas doubles in prices, but consumption of gas is flat. Everything else remains the same price, but doubles in terms of consumption.

Gas = \$25 real, \$50 nominal
All else = \$100 real; \$100 nominal
Total = \$125 real; \$150 nominal

In real terms, gas is down to 20% of our consumption basket (number of units), but still 33% in nominal terms (amount in dollars).

Help?

3. GREAM...get the money..dollar dollar bill y'all!

4. Yes, that makes sense. I didn't realize that you were treating gas as having its own inflation rate. At first I thought that didn't make sense, but upon thinking about it more, I agree it's an interesting way to think about it. You address the issue of how much of the change in is demand and how much is increase in price. Is that the idea?

5. "You address the issue of how much of the change in is demand and how much is increase in price."

Yeah. As well as how much the price increase has impacted aggregate demand as their is less money for other goods / services.