THE BREN SCHOOL OF ENVIRONMENTAL SCIENCE AND MANAGEMENT
at the University of California, Santa Barbara

Presents

"Evaluating U.S. Fuel Economy Standards in a Model with

Producer and Household Heterogeneity"

Part of the 2007-2008 seminar series in Environmental & Natural Resource Economics

Abstract

This paper employs an empirically estimated model to study the equilibrium effects of an increase in the U.S. corporate average fuel economy (CAFE) standards. The model pays close attention to heterogeneity of producers and households and associated differences in responses to the regulation. A distinguishing feature of the model is that it captures the fact that some firms are unconstrained by CAFE regulation, while others choose either to violate the regulation (pay a fine) or to meet the standard. By taking this heterogeneity into account, I find that the profit impacts of CAFE fall almost entirely on domestic producers. In addition, the model develops utility-consistent welfare analyses that allow direct comparison of the CAFE standard with gasoline taxes, considering the simultaneous household decision of vehicle and miles traveled. I find that increased gasoline taxes would reduce gasoline consumption for about one-sixth the welfare cost of a corresponding increment to the CAFE standard. Finally, the model accounts for the dynamic effects of CAFE on used vehicle markets – effects that turn out to be important to the welfare impacts. The consumer surplus changes in used car markets make up nearly half of the gross welfare costs of an increase in the CAFE standard. These effects fall disproportionately on low-income households. Contrary to previous findings, the overall welfare costs are regressive.

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