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Differentiating Passenger Vehicles by Fuel Economy: Strategic Incentives and the Cost-Effectiveness of Tradable CAFE StandardsEPA Grant Number: R833675
Title: Differentiating Passenger Vehicles by Fuel Economy: Strategic Incentives and the Cost-Effectiveness of Tradable CAFE Standards
Investigators: Fischer, Carolyn
Institution: Resources for the Future
EPA Project Officer: Wheeler, William
Project Period: March 1, 2007 through July 31, 2008
Project Amount: $80,627
RFA: Market Mechanisms and Incentives: Case Studies and Experimental Testbeds for New Environmental Trading Programs (2006) RFA Text | Recipients Lists
Research Category: Economics and Decision Sciences
The regulation of fuel economy is one of the primary tools for controlling the emissions of greenhouse gases and other pollutants from passenger vehicles in the U.S., as well as for addressing energy security. This study will address an issue that has been overlooked in all previous studies of Corporate Average Fuel Economy (CAFE) standards and its alternatives: that imperfect competition can affect manufacturer incentives to deploy fuel-saving technologies. The resulting market failure can provide an important motivation for regulation, and it can change the relative cost-effectiveness of different market-based approaches, depending on their ability to target the underprovided market segments.
The study will develop analytical foundations for incorporating price discrimination and quality choice into a typical model of Bertrand competition. An existing numerical model of the market for new vehicle sales will be modified and empirically parameterized to conduct policy simulations. New econometric studies of vehicle demand and supply are beyond the scope, but the study will help identify fruitful areas of future empirical research. Sensitivity analysis will be conducted with respect to key parameters influencing price discrimination incentives, in order to help understand when regulations can enhance welfare as well as fuel economy, and when other market-based mechanisms might perform better.
The welfare and distributional effects of alternative fuel economy regulations will be compared, including an increase in existing CAFE standards, allowing for tradable credits, and implementing other design options in a trading scheme, such as sliding standards based on vehicle size or other characteristics. In particular, we will look for novel approaches to a market mechanism that can also address the underprovision of fuel economy in certain market segments. Understanding the form and magnitude of the effects of this kind of market failure is essential to designing appropriate market-based mechanisms to address environmental problems related to fuel consumption. The methods can apply not only to fuel economy in passenger vehicles but also to energy efficiency in other goods like household appliances.