Chapter 11. Fuel Economy: The Case for Market Failure
- ORNL
- Environmental and Energy Analysis
- University of California, Davis
The efficiency of energy using durable goods, from automobiles to home air conditioners, is not only a key determinant of economy-wide energy use but also of greenhouse gas (GHG) emissions, climate change and energy insecurity. Energy analysts have long noted that consumers appear to have high implicit discount rates for future fuel savings when choosing among energy using durable goods (Howarth and Sanstad, 1995). In modeling consumers choices of appliances, the Energy Information Administration (EIA) has used discount rates of 30 percent for heating systems, 69 percent for choice of refrigerator and up to 111 percent for choice of water heater (U.S. DOE/EIA, 1996). Several explanations have been offered for this widespread phenomenon, including asymmetric information, bounded rationality and transaction costs. This chapter argues that uncertainty combined with loss aversion by consumers is sufficient to explain the failure to adopt cost effective energy efficiency improvements in the market for automotive fuel economy, although other market failures appear to be present as well. Understanding how markets for energy efficiency function is crucial to formulating effective energy policies (see Pizer, 2006). Fischer et al., (2004), for example, demonstrated that if consumers fully value the discounted present value of future fuel savings, fuel economy standards are largely redundant and produce small welfare losses. However, if consumers value only the first three years of fuel savings, then fuel economy standards can significantly increase consumer welfare. The nature of any market failure that might be present in the market for energy efficiency would also affect the relative efficacy of energy taxes versus regulatory standards (CBO, 2003). If markets function efficiently, energy taxes would generally be more efficient than regulatory standards in increasing energy efficiency and reducing energy use. If markets are decidedly inefficient, standards would likely be more effective. The chapter explores the roles of uncertainty and loss-aversion in the market for automotive fuel economy. The focus is on the determination of the technical efficiency of the vehicle rather than consumers choices among vehicles. Over the past three decades, changes in the mix of vehicles sold has played little if any role in raising the average fuel economy of new light-duty vehicles from 13 miles per gallon (mpg) in 1975 to 21 mpg today (Heavenrich, 2006). Over that same time period, average vehicle weight is up 2 percent, horsepower is up 60 percent, passenger car interior volume increased by 2 percent and the market share of light trucks grew by 31 percentage points. Historically, at least, increasing light-duty vehicle fuel economy in the United States has been a matter of manufacturers decisions to apply technology to increase the technical efficiency of cars and light trucks. Understanding how efficiently the market determines the technical fuel economy of new vehicles would seem to be critical to formulating effective policies to encourage future fuel economy improvement. The central issue is whether or not the market for fuel economy is economically efficient. Rubenstein (1998) lists the key assumptions of the rational economic decision model. The decision maker must have a clear picture of the choice problem he or she faces. He should be fully aware of the set of alternatives from which to choose and have the skill necessary to make complicated calculations needed to discover the optimal course of action. Finally, the decision maker should have the unlimited ability to calculate and be indifferent to alternatives and choice sets.
- Research Organization:
- Oak Ridge National Lab. (ORNL), Oak Ridge, TN (United States)
- Sponsoring Organization:
- USDOE Office of Energy Efficiency and Renewable Energy (EERE)
- DOE Contract Number:
- DE-AC05-00OR22725
- OSTI ID:
- 1036647
- Country of Publication:
- United States
- Language:
- English
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