Biofuels policies and fuel demand elasticities in Brazil

Biofuels are often seen by policymalcers as solutions to concerns about the environment, energy diversification, and rural development. To understand the impacts of biofuel policy, however, it is important to understand demand elasticities. Brazil, a leader in biofuels, provides a unique setting to increase our knowledge about biofuel policy and the interactions within and between the gasoline and ethanol markets. We estimate own-price, cross-price, and income elasticities of the demand for ethanol and gasoline using a novel instrumental variable approach to control for the inherent endogeneity between supply and demand. This results in own-price elasticities for both fuels higher than previous literature suggests: approximately -0.9 for gasoline and -1.5 for ethanol. Income elasticities for both fuels are approximately 0.8. We also examine the elasticity impacts following the introduction of flex-fuel cars into the Brazilian market. By estimating the model with over 100 subsamples across time, we find that cross-price elasticities become positive, significant, and increasing, but only after larger market penetration of flex-fuel cars, which occurred approximately three years after their introduction.