Blog Post

Research Questions for the Midterm CAFE Review: The Fuel Efficiency Gap

Mar 20, 2014 | Alan J. Krupnick

This is the second in a series of blog posts by RFF’s transportation team that will address some of the key research questions for the midterm CAFE review.

[caption id="attachment_7427" align="alignright" width="300"]traffic jam Source: iStockphoto[/caption]

As the first post in this series described, US standards for passenger vehicle fuel economy and greenhouse gas emissions are slated to tighten steeply. By 2025, the greenhouse gas standards require a fleet-wide average that’s equivalent to about 54 miles per gallon. The goals of the standards are to reduce greenhouse gas emissions, improve energy security, and reduce consumers’ fuel costs. When the two regulatory agencies that administer the standards—the Environmental Protection Agency and the National Highway Traffic Safety Administration—estimated the costs and benefits of meeting the standards, the estimated value of fuel savings dominates the other benefits, accounting for about 80 percent of the expected benefits. Indeed, these savings outweigh the expected costs of the regulation by three to one.

With such large fuel savings, we would expect consumers to demand fuel-saving technologies and manufacturers to adopt them. But we don’t see this happening in the market place—a situation known as the fuel efficiency gap.

The literature trying to explain this gap is voluminous and varied, but a recent journal article and working paper stand out. Both argue that of all the explanations for the gap, consumer undervaluation of fuel economy benefits is not one of them. Each paper suggests that consumers are willing to pay close to, if perhaps slightly less than, $1 for $1 worth of expected fuel savings. These results are based on the effects of gasoline prices on actual consumer vehicle choices and on vehicle prices.

There are other possible explanations:

  1. Hidden costs. Maybe the true costs to consumers and to manufacturers are larger than they appear. Perhaps those fuel saving technologies degrade performance or some other attribute of the vehicle. Or maybe there are additional adoption costs (real or perceived), say, from redesigning the vehicle, which possibly are not included in the cost estimates.
  2. Consumer demand. Recall that the recent evidence (see above) is based on how gas prices affect consumer purchasing decisions; it’s possible that consumers would respond differently when manufacturers adopt fuel-saving technology—say, if consumers have better information about gas prices than about their vehicle’s fuel economy.
  3. Consumer heterogeneity and manufacturer competition. Maybe manufacturers are (or appear) slow to act for other reasons. As we discussed at a recent RFF workshop, there’s growing evidence that consumer demand for fuel economy is quite heterogeneous. Consequently, manufacturers don’t choose fuel economy based on average consumer demand. Instead, they may design some vehicles for consumers with a high willingness to pay for fuel savings and other vehicles for consumers with a low willingness to pay. Another possibility is that manufacturers decide to adopt technology based on what their competitors are doing. Either case could cause technology adoption to be slower than if manufacturers simply compared technology costs with the value of the fuel savings.

As far as we can tell, the literature does not provide much evidence for or against these, or any other, explanations. The fuel efficiency gap should be addressed because a lot is at stake—both in cost–benefit analysis of future standards and in policy design. Depending on the answer, the regulatory agencies may need to adjust their cost–benefit approach, which could change the calculations and shed light on whether the slated tightening is justified—or if there should be even tighter standards. And taking into account consumer heterogeneity or competition among manufacturers would suggest that other policies—raising the gas guzzler tax or setting a minimum standard, for example—could yield the same benefits at lower costs as a fuel economy standard.