Short- And Long Term Price Elasticity
It should however be noted that there is every reason to believe that long term price elasticity is higher than short term price elasticity. Although people will respond to a dramatic price hike by canceling leisure related trips or other discretionary trips, they may find it difficult to switch their SUV to a more fuel efficient car overnight, particularly as the value of that SUV is falling on the secondary market. Moreover, although some will switch to public transportation to work, others will find that more difficult. But as time goes by, SUVs are going to get increasingly rare as the new car market will increasingly consist of fuel efficient cars. Moreover, the higher fuel price will increase demand for public transportation and so create new routes and enable more commuters to stop driving their car for work. And also, the higher price of fuel is likely to encourage more people to find jobs closer to their homes.
For all of these reasons, the long term effect on demand is likely to be much higher than the short term effect. It is not just monetary policy that works with time lags, commodity markets also have time lags. This difference in elasticity in the short term and long term is likely to be even higher on the supply side of the market. If oil prices suddenly surge, producers can only respond with higher supply if spare capacity exist. To the extent there is no spare capacity, then supply is in fact inelastic in the short term. However, things are different with regard to the long term. The higher price of oil will encourage producers to explore more, and will also encourage them to drill for known resources. It will take years before these factors will bring out oil to the world market, but eventually it will happen. This means that long term price elasticity for supply could be quite high, even if it is very low in the short term.
This is essentially the explanation for why commodity markets tend to move in cycles.
First you have a boom cycle where there is shortage, which due to the low (but not nonexistent) short term price elasticity will create significant price booms, booms that will last for several years. But then once people switched to more fuel efficient alternatives while at the same time all the new fields get operational, then suddenly there will be excess capacity and prices will fall back significantly. That will however once again encourage people to use more fuel and discourage new exploration and drilling, which eventually after a few more years could create yet another cycle characterized by shortages. And so on and so forth.