change attributable to the shifts in the total observed price change is equal to the ratio of the values in the fifth and fourth columns.

|**Table 3. Decomposition of a Cha**|**nge in B**|<br>**razilian M**|<br>**arket Price**|<br>**s between 2010/11 a**|<br>**nd 2011/12***|||
|---|---|---|---|---|---|---|---|
|||Actual<br>2010/11|Actual<br>2011/12|2011/12 if market<br>curves shifts only**|Observed<br>price change|Change due<br>to shifts|% of price change due to shifts<br>in observed price change|
|Price of anhydrous ethanol|$/liter|1.18|1.42|1.43|0.24|0.25|101|
|Fuel price|$/liter|2.47|2.66|2.53|0.20|0.06|31|
|Market price of hydrous ethanol|$/liter|0.96|1.19|1.20|0.23|0.23|102|
|Consumer price of hydrous ethanol|$/liter|1.54|1.88|1.77|0.34|0.23|69|
|Price of sugarcane|$/tonne|56.11|67.83|73.69|11.72|17.58|150|
|Price of sugar<br>* These simulations assume market<br>** Policies are held at their 2010/11<br>Source: calculated|$/tonne<br>shocks (<br>levels.|700.93<br>shifts) wh|884.00<br>ose magnitu|816.63<br>des correspond to the|183.07<br>medium elasticity|115.70<br>scenario in Ta|63<br>ble 2.|

The fact that half of the values in the last column of Table 3 are more than 100 percent indicates that there are considerable market interaction effects not only between Brazilian policies, but also between the policies and exogenous market changes. For example, if biofuel policies had not changed between 2010/11 and 2011/12 and only structural market changes had occurred, we would have observed an even higher rise in the ethanol price.

While Table 2 reports final shifts in market demand and supply curves that reflect all changes in the domestic Brazilian biofuel policy as well as changes in the rest of the world, from a policy analysis point of view, it is important to analyze market effects of a change in a biofuel policy, assuming all other factors, such as income growth or weather, are unchanged. But before we do so, let us model the endogenous shift in demand between E100 and fuel that is generated by a change in the parity gap between E100 and fuel prices when market changes occur.

# **4. Modeling the Shift in Demand Curves for E100 versus Fuel**

Because a change in the biofuel policy (e.g., an increase in the blend mandate or a reduction in the tax on gasoline), among other things, will affect the relative price of the fuel blend and hydrous ethanol, the composition of fuels consumed will alter accordingly.<sup>18</sup> It is because when the price gap (in energy equivalent) between fuel and E100 narrows, some flex cars owners who previously used hydrous ethanol (e.g., because at then prices it paid them to travel to the nearest E100 pump station), will find it profitable to switch to the blended fuel.<sup>19</sup> In this case, the demand for fuel (measured in GEELs) shifts out by exactly the same amount as the

> 18 A change in the price of fuel and hydrous ethanol affects the consumers’ decision on how many miles to drive. Therefore, in the scenario analysis consumers not only shift between hydrous ethanol and fuel (anhydrous and gasoline) in response to shocks, but also change the total mileage driven.

> 19 Note that this is only possible for flex cars, as regular fuel (non-flex) vehicles are not able to run on E100.

18