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Elasticity indices for economic analysis: a case study for hydrous ethanol and
gasoline in Brazil

Conference Paper · July 2013

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Elasticity indices for economic analysis: a case study for hydrous ethanol
and gasoline in Brazil

Paulo Henrique de Mello Sant’Ana1

1
Center of Engineering, Modeling and Applied Social Sciences; Federal University of ABC (UFABC). Rua Santa Adélia,
166. Bangu. Santo André - SP – Brazil. P.O Box 09210-170. Phone/Fax :+55 11 4996-8278 paulo.santana@ufabc.edu.br
, phmsantana@gmail.com

Abstract

Elasticity is frequently used in economics to analyse how the change of a variable affect others. Price
elasticity of demand and cross price elasticity of demand are often used in energy economics, but these indices
have limitations if there are close substitutes for a good with similar prices. The objectives of this paper are to:
(1) Calculate price elasticity of demand and cross price elasticity of demand for hydrous ethanol and gasoline
for flex-fuel vehicles in Brazil, also showing the limitations of both indices; and (2) Propose an elasticity
index that has better results than elasticity of demand and cross price elasticity of demand for the case studied.
The results show that a fuel may be elastic or inelastic in different periods, depending on the price difference
of its direct substitute. If the price difference is high, price elasticity of demand tends to be inelastic. However,
if the price difference is low, price elasticity of demand tends to be elastic. Price elasticity of demand and
cross price elasticity of demand don’t take into account seasonal effects from one period to another. This
paper proposes an index called relative price elasticity of relative demand ( to overcome seasonal effects,

considering the relative changes of price and demand. In general, index has better results than elasticity of

demand and cross price elasticity of demand for the case studied. Relative price elasticity of relative demand
( may be useful in econometric modeling and market analysis.

Keywords: elasticity; flex-fuel vehicles; fuel market.

1. Introduction

Elasticity is frequently used in economics to analyse how the change of a variable affect others. Two of the
most used elasticity in energy economics are price elasticity of demand and cross price elasticity of demand.
Price elasticity of demand (equation 1) measures the sensitivity of quantity demanded to price change, where
p is the price and q is the demand of good x. Cross price elasticity of demand (equation 2) measures the
sensitivity of the demand for a good to a change in the price of another good, where p is the price, q is the
demand, x and y are goods.

[equation 1]

[equation 2]

Hsiao et Hsiao (1985), Abdel-Khalek (1998), Liu (1983), Bentzen et Engsted (1993), Boonekamp (2007),
Brons et al (2008), He et al (2011), Fan and Hyndman (2011), Fatima et al (2012) are examples of calculation
of price elasticity for energy modelling, market analysis and policymaking. Frondel (2004) calculated cross
price elasticity of demand to understand and appreciate energy substitution.

When calculating price elasticity of demand and cross price elasticity of demand for flex-fuel1 vehicles in
Brazil, the results were not consistent with market behavior. The limitation of both indices when analyzing
real data was the motivation for the research of another elasticity index.

The objectives of this paper are to: (1) Calculate price elasticity of demand and cross price elasticity of
demand for hydrous ethanol and gasoline for flex-fuel vehicles in Brazil, also showing the limitations of both
indices; and (2) Propose an elasticity index that has better results than elasticity of demand and cross price
elasticity of demand for the case studied.

Section 2 shows how the fuel market for light vehicles works in Brazil. Section 3 describes the limitations of
price elasticity of demand and cross price elasticity of demand, calculating these indices for hydrous ethanol
and gasoline in the Southwest region of Brazil. Section 4 shows the relative price elasticity of relative demand

1
Flex-fuel vehicles runs with hydrous ethanol and gasoline in any rate (from 0% to 100%)
index created. Furthermore, it explains why it is a better index than price elasticity of demand and cross price
elasticity of demand for the case studied.

2. Fuel market for light vehicles in Brazil: ethanol, gasoline and flex fuel

The oil crisis of 1973 stimulated the Brazilian government to launch a program to foster ethanol production
from sugarcane called PRO-ALCOHOL. PRO-ALCOHOL was launched by the Government in two variants:
(1) compulsorily using 10% anhydrous ethanol as an additive to gasoline, not requiring changes in the motors;
and (2) voluntarily using 100% hydrous ethanol (95% ethanol + 5% water) in modified Otto cycle motors
(Goldemberg, 2006).

The car manufacturers have made a few adaptations, and hydrous ethanol vehicles dominated national sales in
the 80s. Hydrous ethanol shortage in the late 80s has reduced customer confidence, drastically reducing
hydrous ethanol car sales. In the 90s flex-fuel technology for light vehicles was developed. Flex-fuel vehicles
run with gasoline and hydrous ethanol in any rate (from 0% to 100%). According to the National Car
Manufacturing Association (ANFAVEA), flex-fuel car sales began in 2003. This technology put hydrous
ethanol back in the market. Since then, flex-fuel vehicles owners can choose hydrous ethanol or gasoline in
the gas station, depending on their relative price. The harvest of sugar cane officially begins in April, but is
harvested primarily between May and November. Ethanol price is usually lower during this period.

In 2011, flex-fuel cars reached 91% of total sales for light vehicles in Brazil. Flex-fuel car fleet reached 45%
in 2010 and is expected to increase up to 86% in 2020 (UNICA, 2011). Table 1 shows the evolution of light
vehicles sales in Brazil. It is possible to notice that flex-fuel car sales are dominating national sales since
2006, reaching 91% in 2011.

Table 1: evolution of light vehicles sales in Brazil (2005-2011)

Gasoline Ethanol Flex-fuel % of flex-fuel

Year Total
vehicle sales vehicle sales vehicle sales vehicle sales
2005 1.151.069 43.278 776.164 1.970.511 39%
2006 815.849 758 1.249.062 2.065.669 60%
2007 646.266 3 1.719.745 2.366.014 73%
2008 534.949 0 1.948.941 2.483.890 78%
2009 322.868 0 2.241.820 2.564.688 87%
2010 560.348 0 2.256.158 2.816.506 80%
2011 280.704 0 2.876.173 3.156.877 91%
Source: ANFAVEA (2012)

Table 2 shows the evolution of light vehicle fleet in Brazil. Flex-fuel car fleet is expected to increase in the
future, since national sales are increasing in a higher rate.
Table 2: evolution of vehicle fleet since 2005 in Brazil.

Gasoline % of flex-fuel
Year Flex-fuel fleet Ethanol fleet Total fleet
fleet car fleet
2005 1.183.574 15.872.979 2.230.679 19.287.232 6%
2006 2.603.914 15.541.077 2.032.710 20.177.701 13%
2007 4.586.512 15.085.856 1.845.330 21.517.698 21%
2008 6.878.189 14.555.523 1.670.508 23.104.220 30%
2009 9.467.825 13.991.052 1.508.263 24.967.140 38%
2010 12.244.937 13.455.428 1.358.358 27.058.723 45%
2011 14.944.734 12.995.272 1.220.419 29.160.425 51%
Source: UNICA (2012)

Section 3 describes the limitations of price elasticity of demand and cross price elasticity of demand. A case
study for flex-fuel vehicles in Brazil is used to show these limitations.

3. Limitations of price elasticity of demand and cross price elasticity of demand

Southwest region is the business-economic center of Brazil. It’s was the responsible for 70% of hydrous
ethanol and 47% of gasoline consumption in 2011 (ANP, 2012).

All gas stations sell hydrous ethanol and gasoline in Brazil. Hydrous ethanol (called just ethanol from this part
of the paper) has a lower heating value (LHV) of 5.097 kcal/l. Gasoline with 20% of anhydrous ethanol has a
LHV of 7.254 kcal/l. Table 3 shows the evolution of gasoline and ethanol sales and prices in the Southwest
region of Brazil. Sales are shown in cubic meters. Prices are shown in current Brazilian Real per litre (R$/l),
and also in current 10,000 x Real per kilocalories (10,000 R$/kcal). The conversion is made to consider the
LHV, since gasoline and ethanol have different energy amount per litre.

Flexible fuel car fleet in Brazil is shown in the same table. The higher the number, the greater the propensity
of flex-fuel consumers to switch fuel when there are changes in relative prices of gasoline and ethanol.

The difference between the price of ethanol and gasoline, in terms of LHV, is also in Table 3. It shows the
propensity of flex-fuel vehicles owners to switch fuel. If this difference is zero, it means that the price of
ethanol and gasoline is equivalent in energy terms.

The percentage in total sales of ethanol is in the last column of Table 3. This number shows how fuel price
changes reflect the consumer’s choice. Values highlighted in the last column mean that the total variation
from one period to the next is greater than 1.0% in modulus. This means that the flex-fuel vehicles owners
have changed from one fuel to another significantly within a month. The other values mean that total variation
from one period to the next is equal or lower than 1.0% in modulus.
It’s possible to notice in Table 3 that if price difference is close to zero, a small change in the relative price
leads to a significant change in the percentage of ethanol in total sales. This result is reasonable because there
is a considerable flex-fuel fleet since 2009 in Brazil, as shown in Table 2. As flex-fuel vehicles fleet increases
in Brazil, this fact tends to increase as the relative price between fuels is close to zero and price changes occur.

A conclusion that can be inferred from Table 3 is that when price difference between fuels is high (positive or
negative), the change in the relative price don’t affect significantly the percentage of ethanol in total sales
from one month to another. However, if price difference between fuels is low (close to zero), the change in the
relative price usually affect the demand structure from one month to another. Highlighted values help to check
it.

Price elasticity of demand and cross price elasticity of demand should show that this situation was supposed to
happen. However, next section shows that the results were not reasonable.

Table 3: market data for ethanol and gasoline in Brazil

Gasoline -
Ethanol - Ethanol Gasoline
average Gasoline
average - Gasoline Ethanol average
Y price in - average Percentag
price in the average sales in the sales in the price less
e the price e - ethanol
Month Southwest price Southwest Southwest ethanol
a Southwest (R$/ sales/total
region (R$/ region (m3) region average
r region kcal)x sales
(current kcal)x * (m3) * price(R$/
(current 10.000
R$/l) * 10.000 kcal) x
R$/l) *
10.000
jan/09 2,452 1,355 3,38 2,66 948.156 822.008 0,72 46,4%
feb/09 2,453 1,383 3,38 2,71 906.922 782.476 0,67 46,3%
mar09 2,448 1,355 3,37 2,66 977.478 879.177 0,72 47,4%
apr/09 2,440 1,289 3,36 2,53 988.118 925.110 0,83 48,4%
may/09 2,434 1,252 3,36 2,46 936.894 873.350 0,90 48,2%
jun/09 2,422 1,203 3,34 2,36 948.296 903.364 0,98 48,8%
jul09 2,422 1,239 3,34 2,43 981.118 932.895 0,91 48,7%
aug/09 2,538 1,270 3,50 2,49 941.276 918.155 1,01 49,4%
sep/09 2,417 1,340 3,33 2,63 973.486 971.967 0,70 50,0%
oct/09 2,490 1,603 3,43 3,15 1.063.220 985.354 0,29 48,1%
nov/09 2,512 1,573 3,46 3,09 989.547 860.693 0,38 46,5%
2009

dec/09 2,489 1,615 3,43 3,17 1.198.451 1.005.525 0,26 45,6%

jan/10 2,530 1,822 3,49 3,57 1.160.392 629.813 -0,09 35,2%
feb/10 2,557 1,860 3,52 3,65 1.145.379 544.930 -0,12 32,2%
mar10 2,530 1,662 3,49 3,26 1.238.103 740.336 0,23 37,4%
apr/10 2,501 1,522 3,45 2,99 1.101.933 826.948 0,46 42,9%
may/10 2,489 1,415 3,43 2,78 1.065.805 900.087 0,65 45,8%
jun/10 2,478 1,344 3,42 2,64 1.051.085 901.211 0,78 46,2%
jul/10 2,479 1,383 3,42 2,71 1.092.939 942.803 0,70 46,3%
aug/10 2,482 1,437 3,42 2,82 1.085.833 911.877 0,60 45,6%
sep/10 2,486 1,457 3,43 2,86 1.092.070 922.452 0,57 45,8%
2010

oct/10 2,509 1,579 3,46 3,10 1.115.421 882.958 0,36 44,2%

 nov/10 2,524 1,626 3,48 3,19 1.130.640 884.883 0,29 43,9%
dec/10 2,539 1,698 3,50 3,33 1.340.027 956.336 0,17 41,6%
jan/11 2,550 1,759 3,52 3,45 1.131.713 773.733 0,06 40,6%
feb/11 2,555 1,785 3,52 3,50 1.170.342 791.707 0,02 40,4%
mar/11 2,606 2,018 3,59 3,96 1.492.981 530.640 -0,37 26,2%
apr/11 2,770 2,199 3,82 4,31 1.563.489 366.190 -0,50 19,0%
may/11 2,807 1,907 3,87 3,74 1.338.124 637.147 0,13 32,3%
jun/11 2,709 1,756 3,73 3,45 1.265.763 749.828 0,29 37,2%
jul/11 2,705 1,839 3,73 3,61 1.309.175 683.364 0,12 34,3%
aug/11 2,702 1,853 3,72 3,64 1.393.274 716.182 0,09 34,0%
sep/11 2,735 1,953 3,77 3,83 1.426.721 590.393 -0,06 29,3%
oct/11 2,739 1,943 3,78 3,81 1.397.185 618.605 -0,04 30,7%
nov/11 2,731 1,970 3,76 3,87 1.423.133 583.844 -0,10 29,1%
2011

dec/11 2,732 1,994 3,77 3,91 1.645.723 604.932 -0,15 26,9%

jan/12 2,724 1,966 3,75 3,86 1.407.604 516.520 -0,10 26,8%
feb/12 2,717 1,904 3,75 3,74 1.417.312 566.791 0,01 28,6%
2012

mar/12 2,726 1,928 3,76 3,78 1.525.624 571.115 -0,03 27,2%

Source: * National Agency of Petroleum, Natural Gas and Biofuels (ANP)
** Brazilian Sugarcane Industry Association (UNICA)

Price elasticity of demand for gasoline and ethanol and cross price elasticity of demand for gasoline (x) –
ethanol (y) and ethanol (x) – gasoline (y) were calculated to analyze the response of demand to variation in
prices of both fuels. The indices consider the values of price and demand in the same row and the next one.

Table 4 shows the results on a monthly basis, together with the price difference between gasoline and ethanol
in terms of LHV and the percentage of ethanol in total sales in the Southwest region of Brazil. Values
highlighted in the elasticity columns are elastic (> 1.0). The last column of Table 1 is explained in the next
section.

Highlighted values in grey means that market should show an elastic behaviour, because the variation from
one period to another is greater than 1,0% in modulus. White cells mean that the percentage of ethanol in total
sales column should be inelastic, because the variation from one period to another is equal or less than 1,0% in
modulus. Highlighted values only indicate how the market should behave, but doesn’t reflect any scientific
method.

From January to August 2009, the high price difference between gasoline and ethanol didn’t change the
percentage of ethanol in total sales significantly. Price elasticity of demand and cross price elasticity of
demand data is not consistent with market behavior in this period. The numbers should be inelastic, but the
majority is elastic.

From September 2009 to April 2010, the low price difference between gasoline and ethanol made the market
more sensitive to relative price changes, reflecting the percentage of ethanol in total sales. Price elasticity of
demand for gasoline and cross price elasticity of demand for ethanol (x) – gasoline (y) are elastic in this
period. It reflects market behaviour. However, from May 2010 to August 2010 these indices should be
inelastic, but they are not.

Price elasticity of demand for ethanol data is consistent from September 2009 to November 2010, with just a
few exceptions (September 2009, June 2010 and September 2010). Cross price elasticity of demand for
gasoline (x) - ethanol (y) shows some consistent data from September 2009 to November 2010, but it’s not for
September 2009, December 2009, January 2010, February 2010, April 2010, June 2010, September 2010 and
November 2010.

From December 2010 to January 2012, market was supposed to be more sensitive to relative price changes in
most of the period, because the price difference between gasoline and ethanol is low. It can be seen in Table 4
that most of the indices are consistent, except for cross price elasticity of demand for gasoline (x) - ethanol
(y). However, price elasticity of demand for gasoline and cross price elasticity of demand for ethanol (x) -
gasoline (y) are volatile. Both indices have high average numbers and high standard deviation.

It’s possible to draw two general conclusions with the elasticity indices calculated in the case studied.

The first is that a fuel may be elastic or inelastic in different periods, because it depends on the price
difference of its direct substitute. If the price difference is high, price elasticity of demand tends to be
inelastic. However, if the price difference is low, price elasticity of demand tends to be elastic.

The second is that price elasticity of demand and cross price elasticity of demand don’t take into account
seasonal effects from one period to another. This fact may affect one or both variables. For example, in the
case studied, there are months that customers use more or less their vehicles because of the number of days or
vacation. This fact would change the demand from one period to another for both fuels, even if price
wouldn’t. This would cause high elastic numbers from one month to another in price elasticity of demand and
cross price elasticity of demand.

Next section proposes an elasticity index that overcomes seasonal effects, considering the relative changes of
price and demand.
Table 4: elasticity indices for ethanol and gasoline in Brazil

Cross Cross
Gasoline Relative
price price
average price
Price elasticity elasticity
price less Percentage - Price elasticity
Flexibl elasticity of of
ethanol Hydrous elasticity of relative
e fuel of demand - demand -
Year Month average ethanol of demand
fleet in demand - gasoline hydrous
price sales/total demand - change -
Brazil hydrous (x) ethanol
(R$/ sales gasoline hydrous
ethanol hydrous (x)
kcal)x ethanol
ethanol gasoline
10.000 /gasoline
(y) (y)

jan/09 0,72 46,4% 106,6 2,3 2,1 117,9 0,2

feb/09 0,67 46,3% 38,2 6,2 3,9 60,6 2,5
mar09 0,72 47,4% 3,3 1,1 0,2 16,0 0,9
apr/09 0,83 48,4% 21,1 1,9 1,8 22,8 0,2
may/09 0,90 48,2% 2,5 0,9 0,3 7,0 0,7
jun/09 0,98 48,8% #DIV/0! 1,1 1,2 #DIV/0! 0,1
38,0%
Jul/09 0,91 48,7% 0,8 0,6 1,6 0,3 1,1
aug/09 1,01 49,4% 0,7 1,1 0,6 1,2 0,2
sep/09 0,70 50,0% 3,1 0,1 0,5 0,5 0,5
oct/09 0,29 48,1% 7,7 6,8 3,7 14,1 2,1
nov/09 0,38 46,5% 23,1 6,3 7,9 18,4 1,2
2009

dec/09 0,26 45,6% 1,9 2,9 0,2 22,7 3,1

jan/10 -0,09 35,2% 1,2 6,5 0,6 12,6 12,0
feb/10 -0,12 32,2% 7,7 3,4 0,8 34,0 2,9
mar10 0,23 37,4% 9,6 1,4 1,3 10,2 3,1
apr/10 0,46 42,9% 6,8 1,3 0,5 18,4 1,9
may/10 0,65 45,8% 3,1 0,0 0,3 0,3 0,3
jun/10 0,78 46,2% 98,7 1,6 1,4 114,4 0,2
45,0%
jul/10 0,70 46,3% 5,4 0,8 0,2 27,1 0,7
aug/10 0,60 45,6% 3,6 0,8 0,4 7,2 0,5
sep/10 0,57 45,8% 2,3 0,5 0,3 4,6 0,9
oct/10 0,36 44,2% 2,3 0,1 0,5 0,4 0,5
nov/10 0,29 43,9% 31,2 1,8 4,2 13,6 2,7
2010

dec/10 0,17 41,6% 35,9 5,3 4,3 44,1 1,1

jan/11 0,06 40,6% 17,4 1,6 2,3 11,8 0,9
feb/11 0,02 40,4% 13,8 2,5 2,1 16,5 5,5
mar/11 -0,37 26,2% 0,8 3,5 0,5 4,9 13,3
apr/11 -0,50 19,0% 10,8 5,6 1,1 55,4 6,0
may/11 0,13 32,3% 1,5 2,2 0,7 5,1 5,2
jun/11 0,29 37,2% 23,2 1,9 0,7 60,0 2,5
51,0%
jul/11 0,12 34,3% 57,9 6,3 8,4 43,3 1,9
aug/11 0,09 34,0% 2,0 3,3 0,4 14,4 4,8
sep/11 -0,06 29,3% 14,2 9,3 4,0 32,7 10,4
oct/11 -0,04 30,7% 6,4 4,0 1,3 19,2 4,4
nov/11 -0,10 29,1% 427,2 3,0 12,8 98,6 10,2
2011

dec/11 -0,15 26,9% 49,4 10,4 10,3 49,9 0,1

 jan/12 -0,10 26,8% 2,7 3,1 0,2 37,9 3,1
feb/12 52,0% 0,01 28,6% 0,1 0,0 6,1 2,3 7,4
2012

mar/12 -0,03 27,2%

Average 26,0 2,9 2,4 25,1 3,1
Standard Deviation 71,7 2,6 3,1 26,7 3,5

4. Relative price elasticity of relative demand change: a better index for market
analysis

The elasticity index proposed in this section considers the market seasonality of both products from one
period to another. Furthermore, it considers the relative changes of price and demand of two goods. The
elasticity index is called relative price elasticity of relative demand ( ). Equation 3 shows the created index,

where p is the price, q is the demand, x and y are goods. It doesn’t matter which variable is x or y, because the
results are the same in modulus.

Values of between 0 and 1 are inelastic. It means that relative changes in the demand and price of any

goods have a relatively small effect on the quantity of the goods demanded.

Values of above 1 are elastic. It means that relative changes in the demand and price of any goods

have a relatively large effect on the quantity of the goods demanded.

[equation 3]

The last column in Table 4 shows the results. Values highlighted are elastic (> 1.0).

From January to August 2009, market indicated that numbers should be inelastic, as explained in the section
3. Relative price elasticity of relative demand for ethanol and gasoline ( ) data is consistent with market

behavior, except in February 2009 and July 2009.

From October 2009 to August 2010, data is consistent, except in November 2009. However, is lower

than other elasticity indexes in this month. From September 2010 to February 2012, data show better

results than other elasticity indexes.

In general, index has better results than elasticity of demand and cross price elasticity of demand for the

case studied.

5. Conclusion

Price elasticity of demand and cross price elasticity of demand are often used in energy economics, but these
indices have limitations if there are close substitutes for a good with similar prices.

The case study of ethanol and gasoline for flex-fuel vehicles in Brazil shows that a fuel may be elastic or
inelastic in different periods, depending on the price difference of its direct substitute. If the price difference is
high, price elasticity of demand tends to be inelastic. However, if the price difference is low, price elasticity of
demand tends to be elastic. Another finding is that price elasticity of demand and cross price elasticity of
demand don’t take into account seasonal effects from one period to another.

The elasticity index proposed considers the market seasonality of both products from one period to another.

In general, index has better results than elasticity of demand and cross price elasticity of demand for the

case studied. It considers the relative demand change of relative price change, which the price elasticity of
demand and cross price elasticity of demand indices do not consider.

Relative price elasticity of relative demand ( may be useful in econometric modeling and market analysis.

A natural sequence of this work would be the study of three or more variables in an expanded index,

building a matrix of relative demand and price changes.

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