MIT Sloan economist on “Pain at the Pump”

MIT Sloan Prof. Christopher Knittel

My latest research* looks at how consumers adjust to high gas prices by changing the kinds of car they buy, and the prices they pay. What launched this research was the debate around the effectiveness of a gas tax to reduce climate change; the goal was to determine whether consumers undervalue fuel economy. If consumers do undervalue fuel economy, then such a tax would not shift enough consumers to buy smaller, more fuel-efficient automobiles.

 I try to do my research with an eye toward showing policymakers what will happen if they adopt Policy X over Policy Y. I am not a granola environmentalist, but I do see a lot of inefficient policies out there, and as an economist that’s frustrating.

And here’s the thing…

At the moment, the US relies on a variety of subsidies and “performance standards” to reduce greenhouse gas emissions from the transportation sector. On the fuel side, we have ethanol subsidies and the Renewable Fuel Standard, which is an implicit subsidy program. On the vehicle side, we have Corporate Average Fuel Economy Standards, or CAFE standards, which dictate the average fuel economy of an automaker’s annual fleet. The current standard for passenger cars is 30.2 mpg. The standard for light-trucks — a classification that also includes SUVs under 8,500 pounds — is 24.1.

On the electricity side, lawmakers also use the Energy Star program, which was created in the early 1990s, to force appliance makers to create more efficient products. Policymakers seem to believe that consumers are not going to buy the correct dishwasher, or the correct air-conditioner. So instead, they regulate the manufacturer of these appliances to comply with certain efficiency requirements, rather than let the price of electricity reflect the social cost of that dishwasher or air-conditioner.

My research shows that performance standards – such as CAFE standards – may be more inefficient than previously thought, and that pricing instruments, such as a gas tax, would likely have a bigger impact on reducing greenhouse gas emissions.

My colleagues and I found that a jump in the price of gas causes a significant change in the kinds of cars that consumers buy and the price they pay for them. A $1 increase in the gasoline price changes the market shares of the most and least fuel-efficient new cars by +20% and -24%, respectively. Changes in gasoline prices also change the relative prices of the most fuel-efficient cars and the least fuel-efficient cars. For new cars, the relative price increase for fuel-efficient cars is $363 for a $1 increase in gas prices; for used cars it is $2839. (For comparison: a $1 increase in gas prices alters the budget of the average household by about $50 a month.)

I am not naïve, and I realize that no politician has ever been elected on a platform of: ‘I’m going to raise your gas prices,’ but by advocating alternatives, they’re promoting inefficient policies that simply hide these inflated costs. There’s a lot of resistance from consumers about the prospect of a gas or carbon tax, but I believe this is mainly because consumers are misled to believe that performance standards are cheaper.

The run-up in the price of gas in recent years has been substantial enough to make top auto executives give up their historic opposition to gasoline price taxes: some have even suggested that Congress should consider a variable gasoline tax that would create a $4 floor for retail gasoline prices.

Mike Jackson, CEO of AutoNation, the largest U.S. dealership chain, told the Wall Street Journal: “We need more expensive gasoline to change consumer behavior. Otherwise, Americans will continue to favor big vehicles, no matter what kind of fuel-economy standards the government imposes on automakers.”

Four dollars a gallon, he added, ‘is a good start.’ Hear, hear.

* Pain at the Pump: The differential effects of gasoline prices on new and used automobile markets; Meghan R. Busse, Christopher R. Knittel, Florian Zettelmeyer; National Bureau of Economic Research; December 2009