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Automobile fuel economy: what is it worth?

I. INTRODUCTION

Concern about energy efficiency touches a broad cross section of the populace. Supporters of increased automobile fuel economy cite global warming and air quality concerns, desire to conserve fossil fuels, and enhancement of domestic energy security. The Organization of Petroleum Exporting Countries (OPEC) announcement of a quota cutback in February 2004 rattled world oil markets, leading almost immediately to increased market prices, proving its continuing ability to significantly influence world oil markets. Government interventions in automobile markets include mandated fleet average fuel economy standards, gas guzzler vehicle taxes, gas taxes, and tailpipe emissions regulations.

In spite of the increased share of sport utility vehicles and light trucks as a percentage of new passenger vehicle sales, average fuel economy is virtually unchanged since 1981 (EPA, 2004), yet vehicle weight has increased by 24%, horsepower 93%, and 0 mph to 60 mph acceleration has improved by 29%. In other words, consumers are buying more size and performance without sacrificing in terms of operating costs. Since 1987, however, fleet average fuel economy for cars and light trucks has declined by about 6%.

But does this lack of improvement in fuel economy mean that consumers do not value fuel savings? In light of legislation proposed to mandate increases in fuel economy and subsidize research into alternative-fuel and hybrid vehicles, an understanding of consumers' valuation of fuel economy can aid in anticipating market reaction to such legislation and the potential impact on consumer well-being. This research estimates the value consumers place on fuel economy through a hedonic analysis of model year 2001 new car sales in the United States to determine if consumers accurately value the fuel savings of improved fuel economy. In addition, the gas guzzler tax is considered explicitly to determine the extent to which consumers internalize this potential added cost and to what extent it influences consumers' valuation of fuel economy.

II. PREVIOUS LITERATURE

Surprisingly few economic studies have attempted to determine consumers' willingness to pay for improvements in automobile fuel economy. The earliest hedonic studies of automobiles were concerned with the estimation of quality-adjusted prices (Court, 1939; Triplett, 1969, 1986; Cowling and Cubbin, 1971; Griliches, 1971; Ohta and Griliches, 1976). Other researchers have focused on valuation of safety features and associated implications for the value of life (Atkinson and Halvorsen, 1984; Dreyfus and Viscusi, 1995; Dunham, 1997). Douglas et al. (1993) considered the relationship between vehicle warranties and vehicle quality, while several others attempted to measure market power exerted by producers in different locations (Mertens and Ginsburgh, 1985; Thompson, 1987).

As fuel economy was not an explicit focus of most of these studies, it was omitted by some and often found to be insignificant due to high correlation with other included variables. Thompson (1987) and Arguea and Hsiao (1993) included fuel economy measured in miles per gallon (mpg) linearly and found inconsistent and insignificant results. Since fuel economy would be expected to be valued by consumers for the fuel savings it provides, automobile price would be more accurately modeled as a function of gallons per mile. An improvement in fuel economy would decrease gallons per mile and have a value of fuel savings directly related to the fuel price per gallon times miles driven.

Atkinson and Halvorsen (1990) and Dreyfus and Viscusi (1995) appropriately consider the inverse of miles per gallon in their analyses, but derive a fuel cost variable by assuming a fuel price and average miles driven. Berry et al. (1995) also recognized the inverse relationship between fuel savings and fuel economy, but assume a fuel price to create an independent variable of price per mile. In contrast to these previous studies, this analysis does not presuppose fuel price or miles driven, in particular because miles driven may either influence a consumer's choice of fuel economy or be influenced by the fuel economy of the vehicle purchased. In either case, the implicit price of fuel economy would be expected to reflect the consumer's fuel cost savings, which would be a function of their expectation of future fuel prices and vehicle miles to be driven.

III. ESTIMATION

A. Model

Automobiles are purchased for the travel services they provide. The utility that a consumer derives from travel services depends, in part, on vehicle characteristics such as comfort, size, safety, and performance, with fuel economy being but one characteristic to consider. Fuel economy is often, although not always, negatively correlated with these other vehicle characteristics. Thus the consumer must balance potential savings in fuel costs from higher fuel efficiency against a preference for larger, safer, or faster vehicles. Over time, technological improvements have led to increases in fuel efficiency with fewer sacrifices in terms of size, safety, and performance, thus reducing consumer aversion to vehicles with higher fuel economy.

This analysis follows the methodology developed by Rosen (1974) for hedonic price analysis. Each automobile is a differentiated bundle of characteristics. In a competitive equilibrium, the price of an automobile will result from the interaction of producers and consumers for different bundles of these characteristics. The price of an automobile can be represented as [P.sub.auto] = P([A.sub.1], [A.sub.2], [A.sub.3],..., [A.sub.n]), where each [A.sub.i] is a characteristic or attribute of the vehicle. The implicit marginal price of any one attribute is the partial derivative of the equilibrium hedonic price function with respect to that attribute:

p([A.sub.k]) = [partial derivative][P.sub.auto]/[partial derivative][A.sub.k] = [P.sub.Ak] ([A.sub.1], [A.sub.2], [A.sub.3],..., [A.sub.n]).

Given an equilibrium market, this value reflects both the consumer's marginal willingness to pay for an additional unit of that attribute and the producer's marginal cost of providing another unit of that attribute in that vehicle.

B. Data and Vehicle Characteristics

The data used in this analysis were obtained from Consumer Reports and Ward's Automotive Report Web sites and includes 130 automobile models, list price, (1) vehicle attributes, and sales quantities for model year 2001 automobiles. In addition to fuel economy, this study considers seven general categories of desired vehicle characteristics: size, power, performance, safety, comfort, reliability, and whether or not the vehicle is classified as a luxury automobile. Because different regulations apply to sport utility vehicles, vans, and light trucks, and because many of these vehicles are used for commercial purposes, these types of vehicles are not included in this analysis. Table 1 shows the summary statistics for the variables included in this hedonic analysis.

Length, width, wheelbase, and curb weight are all indications of vehicle size. Curb weight, however, is likely the best indicator of size, as both length and width are one-dimensional and wheelbase can vary across similar size vehicles depending on vehicle design. Further, among these variables, curb weight has the highest average correlation with the other three size indicators, so it is used in this model as the indicator of vehicle size.

Power has most commonly been measured by horsepower or horsepower divided by curb weight. Zero to 60 miles per hour (mph) acceleration time has also often been used as a measure of vehicle power. Since acceleration is highly correlated with horsepower (-0.64), but is less highly correlated with curb weight than is horsepower (-0.43 versus 0.71), 0 mph to 60 mph acceleration is included as the indicator of power. Performance is measured by turning circle, which is the bumper clearance needed to make a U-turn recorded in feet.

Two safety attributes are included, braking distance and crash test results. Braking is the distance in feet needed for the vehicle to come to a standstill from a speed of 60 mph on dry pavement. The National Highway Traffic Safety Administration (NHTSA) administers crash tests and scores vehicles on a scale of one to five, with five being the best rating, for both front and side crash tests. This hedonic analysis uses the sum of these two ratings as a measure of overall vehicle safety.

Comfort rating is based on reported front seat comfort rating on a scale of one to five, with five being the best. The comfort score assesses noise under normal driving conditions and ergonomic factors such as legroom, headroom, and driving position comfort. Reliability is similarly based on ratings that range from one to five, with five being the most reliable. This test is based on the rate of problems with vital vehicle components such as brakes and transmission.

In the data source, all vehicles were classified as small, coupe, family, wagon, large, sport, upscale, and luxury. Categorizations based on vehicle size (small and large) should be captured in the vehicle size variable discussed above. Sports cars and coupes are generally smaller than average, but are typically differentiated from small cars by power and performance, hence power and performance variables would be expected to pick up the differential value of sports cars and coupes more explicitly in terms of what differentiates them from other vehicles. Tests of the significance of the other vehicle categories found only the luxury classification, representing 6% of the vehicles, to be statistically significant, so it is the only classification included in the final analyses.

The fuel cost of operating an automobile is fuel price per gallon multiplied by miles driven divided by miles per gallon:

($/gal) X miles driven/mpg.

Higher fuel costs associated with lower fuel economy would be expected to reduce the willingness to pay for a vehicle, all else being equal. Since fuel economy is expected to be valued by automobile consumers in relation to the fuel cost savings provided, automobile price would be expected to be inversely related to fuel economy.

Fuel economy numbers are based on U.S. Environmental Protection Agency (EPA) tests. Both city mileage and highway mileage are considered, as well as a weighted average based on an EPA assumption of 45% highway driving and 55% city driving. This weighted average is also used in determining the gas guzzler tax (EPA 2001). The Energy Act of 1978 established the gas guzzler tax on the sale of new model year vehicles for which the weighted average fuel economy was less than 22.5 mpg. It increases as fuel economy declines for every 1 mpg decrease down to 12.5 mpg. Among the 2001 model year vehicles included in this analysis, none averaged less than 18.5 mpg. Relevant tax values are shown in Table 2.

Curb weight, comfort, safety, reliability, and luxury status are all expected to contribute positively to vehicle price. Since acceleration is measured in seconds to achieve a given speed, and turning circle and braking distance and measured in feet to accomplish the tasks of turning and braking, these variables are expected to have a negative relationship to vehicle price. Ceteris paribus, vehicles subject to the gas guzzler tax would also be expected to sell for less, as consumers consider the added cost as part of their total cost of acquiring the vehicle, reducing their willingness to pay for the vehicle. Finally, the coefficient on the inverse of miles per gallon is expected to be negative, indicating that lower levels of fuel economy increase fuel costs, resulting in a lower willingness to pay.

IV. EMPIRICAL RESULTS

Four linear models are estimated using White's heteroskedastic consistent standard error correction, with fuel economy entered inversely in all of the models. (2) The first model includes city fuel economy, the second includes highway fuel economy, the third includes both city and highway fuel economy, and the last includes the weighted fuel economy. Automobile consumers most likely consider both city and highway fuel economy, so models 3 and 4 are likely more representative, but the others are included for comparison. Results are shown in Table 3.

All coefficients are of the expected sign and are fairly consistent across the models. Only the reliability rating and the third tier of the gas guzzler tax were not statistically significant across all the models. The coefficient values for the gas guzzler taxes, particularly the first and fourth tier, are generally higher than expected. Since these variables are dummy variables, the coefficient is expected to be close to the negative of the actual value of the tax, yet "Tax 1" is about 2.5 times the $1,000 tax and "Tax 4" is at least 60% higher than the actual $2,100 tax across the four models.

Table 4 compares the estimated value of a 1 mpg increase in listed fuel economy to the undiscounted value of actual fuel savings of such an increase. The value of actual fuel savings is based on a U.S. Department of Transportation (DOT) report of an average final vehicle mileage of 145,000 miles and the EPA assumed 45%/55% split on highway versus city driving mileage. In calculating actual fuel savings, fuel efficiency figures are adjusted for in-use shortfall according to EPA estimates of actual mileage of 90% of EPA calculated city mileage and 78% of EPA calculated highway mileage (EPA 2001).

Three calculations were made using different fuel prices: $1.50 per gallon, $1.75 per gallon, and $2.00 per gallon. As a frame of reference, the average retail gasoline price per gallon from September 2000 through November 2001, the time period over which most model year 2001 vehicles were sold, was $1.51 per gallon. Adjusted for in-use shortfall, a 1 mpg increase in listed city fuel economy would be equivalent of a 6.4% average improvement in actual city mileage, while a 1 mpg increase in listed highway fuel economy would equate to a 3% average improvement in actual city mileage. Overall, a 1 mpg increase in the average listed fuel economy equates to a 4.8% improvement in average actual fuel economy.

The estimated values derived from models 1 and 2 clearly suggest overvaluation of fuel savings, but since each of these models excludes one measure of fuel economy, the other is likely picking up some of the influence of the omitted variable, biasing the estimate upward. For model 3, the value of improved city mileage is less than the actual undiscounted fuel savings at an assumed fuel price of $1.50 per gallon, suggesting a discount rate of about 3%. To the extent that consumers expect new vehicles to last longer and fuel prices to be higher, the estimated value of fuel economy reflects relatively high discounting by consumers; for example, 6.5% at a fuel price of $1.75 and 10% for a fuel price of $2.00 per gallon. These calculations are based on the DOT estimates that the average lifespan of a vehicle is just over 13 years and the average new-car buyer trades in at 55,000 miles, approximately every four years. The vehicle is then assumed to be driven gradually fewer miles until the average final mileage of 145,000 is met at 13 years.

In contrast to city mileage estimates, the estimated marginal valuation of highway fuel economy is significantly greater than actual fuel savings in models 2 and 3, again based on the EPA estimate of 45% of total mileage being highway driving and the DOT estimate of 145,000 total miles. If automobile consumers are overestimating fuel cost savings from improvements in highway mileage, it makes sense that average mileage improvements would also be overvalued, especially if consumers are "guesstimating" average fuel economy based on new car sticker information of city and highway fuel economy. This appears to be the case, as model 4 estimates a higher value of an incremental change in fuel economy than the actual fuel cost savings at a price of $1.50 per gallon. It is possible that consumers do not have an accurate idea of the potential fuel savings associated with improvements in fuel economy, particularly as most proponents of fuel economy improvements cite fuel cost savings [see, e.g., Emert (2002) and Sierra Club (2002)], while most opponents focus on safety and freedom of choice issues rather than the declining marginal value of fuel economy improvements as average fuel economy increases [see, e.g., Crandall et al. (2002) and Competitive Enterprise Institute (2003)].

However, for higher fuel prices, the estimate from model 4 using average fuel economy suggests only moderate discounting by consumers, at a rate of about 1% for fuel prices of $1.75 per gallon and 4% for fuel prices of $2.00 per gallon. Figure 1 illustrates this relationship in more detail, showing actual fuel savings in relation to the discount rate for fuel prices ranging from $1.50 per gallon to $2.00 per gallon. These results suggest that if 2001 automobile buyers were accurately anticipating higher fuel prices while discounting fuel savings over time at a rate fairly closely reflecting low real discount rates as had been experienced for some time, (3) their willingness to pay for improved fuel economy was very close to the actual value of the resulting fuel savings.

[FIGURE 1 OMITTED]

This result contrasts significantly with previous research on automobile attributes that most often found inconsistent and insignificant estimated values for fuel economy. Dreyfus and Viscusi (1995) parameterized fuel price and mileage driven to derive an operating cost variable focusing on the estimated rate of discount for fuel economy and safety features of automobiles. However, they estimated the rate of discount in the range of 11% to 17%, much higher than this study, with automobile prices rising by just $0.35 for each $1 increase in fuel costs. Berry et al. (1995) found their miles per dollar variable to be insignificant, while their estimated value for fuel economy measured as miles per gallon increased as fuel economy improved. While they suggest that people buying more fuel-efficient vehicles care more about that attribute and hence are willing to pay more for it, this contradicts the reality that fuel cost savings are smaller for incremental changes in fuel economy as fuel economy increases, due to the inverse relationship between fuel cost savings and fuel economy. This incongruous result could be a result of modeling automobile prices as a linear function of fuel economy rather than the inverse of fuel economy as done in this study.

V. CONCLUSION

In contrast to most past studies, this research finds a positive and significant value for fuel economy reflected in automobile prices, suggesting that automobile consumers reasonably accurately value the fuel cost savings associated with improvements in fuel economy. Further, it appears that they discount at rates approximating real low-risk interest rates prevalent around the time of the study.

Between 1960 and 2001, highway travel in the United States increased about 3.4% per year, a 139% increase overall, an increase that many attribute to low fuel prices. Yet improvements in the fuel economy of automobiles have nearly offset this increase in terms of overall fuel consumption and many continue to push for higher fuel economy standards and higher gasoline taxes. Portney (2002) recently concluded that the federal corporate average fuel economy (CAFE) standards require automobile manufacturers "to produce more fuel efficient cars than large segments of the public appear to want--at least at current gasoline prices."

Mandating higher fuel economy limits consumers' choices in the marketplace and, many argue, costs lives in terms of reduced vehicle safety. If there are externalities associated with current levels of fuel consumption that are not adequately addressed by existing regulations and taxes, then further increasing the price of fuel would give consumers the incentive to improve fuel economy and drive less while retaining choice of vehicles in the marketplace. Whether or not the government should attempt to increase average fuel economy is beyond the scope of this study. Rather, this research can help inform policymakers regarding the value consumers place on improving fuel economy and how the demand for fuel economy might change in response to changes in future expected fuel prices, and hence the effectiveness of fuel taxes or standards in achieving changes in fuel economy over time.

Consumers appear to fully internalize the value of fuel savings associated with increases in fuel economy of conventional automobiles at low discount rates. This indicates that they are behaving rationally, contrary to the findings of earlier studies. Hence, further government regulation to stimulate increases in fuel economy might be warranted under social efficiency considerations, but not based on the assumption that fuel cost savings are undervalued by car buyers or that car buyers discount at irrationally high rates.

This research might also help in understanding decisions regarding adoption of alternative technologies such as hybrid vehicles. This research suggests that consumers are likely to accurately value fuel cost savings associated with such vehicles, leading to rational adoption based on fuel cost savings, at least once they become more informed about and familiar with the features of such vehicles. Of course, other benefits such as reduced pollution, reduced global warming, or reduced energy dependency may also be associated with improved fuel economy, and while this research cannot determine why people value fuel economy, it has nonetheless found that they do positively value it and pay for it via higher automobile prices, all else being equal.
TABLE 1 Summary Statistics

Variable Mean Std Dev Minimum Maximum

Price ($) 23,098 10,217 9095 95,400
Curb Weight (pounds) 3173.3 432.92 1875 4420
Acceleration (seconds) 9.0 1.34 5 12.6
Turning Circle (feet) 39.2 2.32 33 45
Braking (feet) 139.4 6.26 117 153
Crash Test Rating 7.6 1.2 2 10
Comfort Rating 3.8 0.64 2 5
Reliability Rating 3.3 1.18 1 5
Luxury 0.058 0.23 0 1
City (mpg) 15.6 2.86 12 36
Highway (mpg) 33.3 4.10 23 66
Average (mpg) 20.4 3.18 16.0 45.3

TABLE 2 Gas Guzzler Tax

Average mpg Tax Vehicles

At least 22.5 0 59.5%
At least 21.5, but less than 22.5 $1000 9.9%
At least 20.5, but less than 21.5 $1300 14.3%
At least 19.5, but less than 20.5 $1700 3.7%
At least 18.5, but less than 19.5 $2100 12.6%

TABLE 3 Empirical Results Using Actual Gas Guzzler Tax Dummy Variables

Variable Model 1 Model 2

Curb Weight (pounds) 17.94 (29.53) 17.62 (37.52)
Acceleration (seconds) -1541.5 (-17.82) -1836.0 (-19.56)
Turning Circle (feet) -902.5 (-17.97) -957.7 (-18.14)
Braking (feet) -110.34 (-10.38) -137.77 (-12.02)
Crash Test Rating 218.12 (3.01) 388.51 (6.31)
Comfort Rating 1103.0 (7.30) 498.42 (3.38)
Reliability Rating 133.26 (1.73) 181.66 (2.46)
Luxury 15,866 (26.53) 16,963 (28.78)
City (gallons per mile) -129,020 (-6.26)
Highway (gallons per mile) -313,950 (-8.55)
Average (gallons per mile)
Tax 1 ($1,000) -2683.6 (-6.87) -3032.2 (-7.18)
Tax 2 ($1,300) -1808.0 (-6.58) -1866.4 (-5.78)
Tax 3 ($1,700) -43.60 (-0.14) -1531.6 (-4.52)
Tax 4 ($2,100) -3677.6 (-8.67) -5702.3 (-12.25)
Adjusted [R.sup.2] 0.85 0.85

Variable Model 3 Model 4

Curb Weight (pounds) 18.66 (31.27) 18.50 (30.29)
Acceleration (seconds) -1784.0 (-19.79) -1643.5 (-18.14)
Turning Circle (feet) -917.6 (-18.33) -901.0 (-17.96)
Braking (feet) -127.10 (-11.65) -115.88 (-10.63)
Crash Test Rating 232.24 (3.23) 191.25 (2.72)
Comfort Rating 796.87 (5.34) 1024.1 (6.87)
Reliability Rating 105.40 (1.37) 103.94 (1.35)
Luxury 16,192 (27.17) 15,853 (26.73)
City (gallons per mile) -107,000 (-5.05)
Highway (gallons per mile) -269,070 (-7.15)
Average (gallons per mile) -257,560 (-8.03)
Tax 1 ($1,000) -2561.9 (-6.52) -2526.1 (-6.41)
Tax 2 ($1,300) -1357.3 (-4.57) -1488.8 (-5.22)
Tax 3 ($1,700) -174.83 (-0.57) 185.72 (0.60)
Tax 4 ($2,100) -4020.7 (-9.45) -3477.6 (-8.01)
Adjusted [R.sup.2] 0.85 0.85

T-statistics are in parentheses.

TABLE 4 Actual Versus Estimated Value of Fuel Economy

 1 mpg increase in:
 City Highway Average
 mpg mpg mpg

Model 1 $531
Model 2 $282
Model 3 $440 $242
Model 4 $613

Actual undiscounted fuel savings assuming:
145,000 miles, $1.50/gal $514 $110 $561
145,000 miles, $1.75/gal $600 $128 $654
145,000 miles, $2.00/gal $686 $146 $747


1. Actual new vehicle transaction prices are not available.

2. A constrained logarithmic model, with the constraint imposing the direct relationship between automobile price and fuel cost savings, was also estimated, but the linear model had a significantly higher log-likelihood value, resulting in a chi-squared value of 173.0.

3. The 90-day Treasury-bill rates minus the gross domestic product (GDP) deflator ranged from close to zero to about 3.5% during 2000-2001, while AAA bond ratings minus the GDP deflator paid closer to 5% to 5.5% during this time.

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MOLLY ESPEY and SANTOSH NAIR*

Espey: Associate Professor of Applied Economics, Clemson University, Clemson, SC. Phone 864-656-6401, Fax 864-656-5776, E-mail mespey@clemson.edu

Nair: Senior Consultant, IRI AIG GOC, Symphony Service (India) Pvt. Ltd., #13 McGrath Rd., Bangalore 560025, India. Phone 91-80-51331789, E-mail santosh. nair@symphonysv.com
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Date:Jul 1, 2005
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