Gasoline Prices, Fuel Economy, and the Energy Paradox

While relative automobile prices do move substantially in response to gasoline prices, they do not move as much as one might expect.

U.S. consumers spent $286 billion on gasoline in 2007, which suggests that the potential savings from buying more fuel-efficient vehicles is easily in the billions of dollars. In justifying regulations such as Corporate Average Fuel Economy standards, some U.S. policymakers argue that consumers do not fully consider these potential savings when choosing between automobiles.

In Gasoline Prices, Fuel Economy, and the Energy Paradox (NBER Working Paper No. 18583), co-authors Hunt Allcott and Nathan Wozny analyze gas and auto prices from tens of millions of auto transactions to determine whether there is a correlation between changing energy costs and the price of vehicles with varying fuel-economy ratings over time. They find that while relative automobile prices do move substantially in response to gasoline prices, they do not move as much as one might expect: vehicle prices move as if consumers are willing to pay only 76 cents to save one dollar in discounted future gasoline costs. While this result holds up to a number of different assumptions about changes in utilization patterns, new vehicle market shares, and underlying consumer preferences, it varies substantially with the age of used vehicles and assumptions about how consumers forecast future gasoline prices.

Interestingly, the authors show that there is a lag of up to six months before changes in gasoline prices are fully internalized into vehicle price adjustments. This suggests that consumers have "sticky information" -- that is, that consumers and businesses do not immediately update information about such macroeconomic variables as interest rates and inflation.

--Jay Fitzgerald