Drivers who spend too much on fuel efficiency

Arik Levinson, Lutz Sager 05 January 2021

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The US began regulating the average fuel economy of cars and light trucks in the 1970s, followed by Europe, Asia, and Latin America. Initially designed to reduce dependence on imported oil, the rules have been repurposed to reduce local air pollution and now global greenhouse gases. Whatever their primary aim, most of the calculated monetary benefits of tighter standards involve fuel expenses saved by individual drivers. The US standards enacted in 2012 promised to add $1,800 to the upfront cost of a typical new car, but to save drivers more than $5,000 in lifetime fuel expenses.  And the 2020 loosening of those US standards are projected to reverse some of those net savings, lowering new car costs by $800 but adding $900 to $1,200 to future fuel bills.  

Why must manufacturers be required by law to produce and sell cars that drivers should want to purchase? Why aren’t consumers willing to pay for cars that will save them money? Those questions are sometimes referred to as the ‘energy efficiency paradox’, and they apply to all sorts of energy-using consumer durables, such as light bulbs, refrigerators, air conditioners, and in this case, cars. Economic explanations for the paradox involve market imperfections or behavioural irrationalities, such as consumers’ borrowing constraints and information asymmetries (Allcott and Knittel 2018), or inattention and present bias (Gillingham et al. 2019). All of those explanations have the same implication – the incremental cost of a more energy-efficient car (or lightbulb or air conditioner) will be less than its expected incremental energy savings. Investments in upfront energy efficiency would pay for themselves.

In automobile markets, recent economic evidence for the paradox is mixed. Some find that car buyers do indeed undervalue future savings from investing in a more fuel-efficient vehicle, that the cost of incremental efficiency is less than discounted future savings (Allcott and Wozny 2014, Gillingham et al. 2019). Others find no market failure or behavioural quirk, that car prices fully reflect future fuel savings (Busse et al. 2013, Grigolon et al. 2018). Based on those results, regulators’ claims that mandated efficiency improvements save drivers money may or may not be correct, but only for average drivers. However, as Bento et al. (2012) note, individual drivers vary as to how much they drive. Those who drive a lot can potentially save even more, while others may not drive enough to recoup the upfront costs of a more efficient car. 

In a new paper (Levinson and Sager 2020), we use data on individual American drivers and their cars to ask who values future fuel savings. Using the 2009 and 2017 waves of the National Household Travel Survey (NHTS), we test whether each individual car owner would be better off, financially, paying more upfront for a more expensive, more fuel-efficient vehicle, given the gas prices they pay and the distances they drive. As claimed by the regulators, we do find lots of drivers with high annual expenses who could be saving money in more fuel-efficient cars. But we find nearly as many drivers in the opposite position. They own relatively efficient cars but don’t drive enough to make the extra upfront cost worthwhile financially. Those drivers could have saved money purchasing less efficient cars, spending less to buy the cars but more each year to drive them.

This point is illustrated by Figure 1, which uses 24,362 drivers in the NHTS that own cars that could be purchased in either a gas-powered or a hybrid model. Think of the Toyota Camry or Honda Civic. Car buyers have a choice whether to pay more upfront for the hybrid and save on annual fuel costs, or to pay less upfront for the standard gas car and more annually for its fuel. Assuming that the hybrid and gas variants are similar in other attributes such as size and comfort, the comparison isolates the trade-off between upfront costs and future fuel savings. For each driver we calculate the difference between their actual annual fuel costs and what those costs would be in the alternative model, driving the same distances and paying the same fuel prices. For drivers of hybrids, that difference represents their annual savings, relative to what their costs would have been had they purchased the gas car instead. For drivers of the gas models, that difference represents the extra annual fuel costs they pay by failing to opt for the hybrid version.  Figure 1 plots the distribution of those annual individual cost differences for each group. The outlined, unshaded bars show how much the drivers of the 22,025 gas vehicles could be saving in a hybrid. The shaded bars plot the distribution of realized annual savings for the 2,337 drivers who did choose hybrids.

Figure 1 Annual fuel cost differences, owners of gas-powered and hybrid model variants

Notes: For each vehicle in the 2009 and 2017 NHTS that comes in both gas and hybrid versions, we calculate the annual fuel cost difference between the two versions, given mileage and gas prices. The shaded bars represent the cost savings for hybrid drivers relative to driving a gas version of the same car; the outlined bars represent the extra annual costs borne by gas drivers.

Unsurprisingly, the shaded, energy-efficient hybrid distribution appears shifted to the right of the outlined, standard gas distribution. That could be for two reasons, either selection by high-mileage drivers into efficient cars, or post-purchase mileage increases by drivers of efficient cars who face a lower cost of driving them. Surprisingly, however, that rightward shift of the hybrid distribution is small. We show in the paper that the shift is about the magnitude we would expect from only the post-purchase response, the so-called ‘rebound effect’, with no selection by high-mileage drivers into hybrids. Figure 1 looks as if drivers randomly chose their cars, and the ones in efficient cars respond by driving more. 

The wide spread of the fuel cost differences depicted in Figure 1 also suggests potential for financial savings in both directions. A lot of high-mileage drivers own gas cars, at the right end of the outlined bars. They could be saving money in more efficient hybrids. But a lot of low-mileage drivers own hybrids, at the left side of shaded distribution; they could have saved money buying the cheaper gas cars and paying a bit more each year for fuel. 

A full evaluation of these choices, and potential financial savings from switching cars, requires many assumptions about the price differences between the models, vehicle lifetimes, and discount and depreciation rates. But any set of those assumptions leads to a cut-off value in annual cost savings that makes the additional initial cost of a hybrid worthwhile financially. Think of it as a vertical line drawn in Figure 1. Any driver to the right of that line has sufficient annual fuel costs that they could save money in a hybrid. Anyone to the left would be better off in a cheaper gas car. But the two distributions in Figure 1 largely overlap. No matter where we draw the line, no matter what assumptions we make about prices and discount rates, we always find large numbers of drivers making both types of mistakes, at least in the purely financial sense. 

In fact, we find little correlation between individual drivers’ annual fuel expenditures and their fuel economy choices. A driver’s income, sex, age, and education are far more closely associated with their vehicle’s fuel economy. We can rule out several explanations for the disconnect. Rich car purchasers do not seem to consider fuel expenses any more than poorer ones, undermining arguments that borrowing constraints prevent low-income consumers from investing in fuel efficiency. And the disconnect between fuel expenses and vehicle choice holds whether we examine anticipated or realized mileage, ruling out mistaken expectations about future driving as an explanation. 

For the research community, our results present a puzzle. How can car prices reflect the value of fuel economy savings to the average driver, as some find, while individual drivers largely ignore their own financial incentives when choosing a car? For policy analysts, our findings raise questions about the argument made by regulators. It may be true that mandated national fuel economy standards save money for the average car buyer, but they raise costs for many members of that average. Unless the standards can be justified by their environmental benefits, the rules could create almost as many losers as winners. 

References

Allcott, H, and C Knittel (2018), “Are consumers poorly informed about fuel economy? Evidence from two experiments”, American Economic Journal: Economic Policy 11(1): 1-37.

Allcott, H, and N Wozny (2014), “Gasoline prices, fuel economy, and the energy paradox”, Review of Economics and Statistics 96(5): 779-95.

Banzhaf, H S, and M T Kasim (2019), “Fuel consumption and gasoline prices: The role of assortative matching between households and automobiles”, Journal of Environmental Economics and Management 95: 1-25.

Bento, A M, S Li, and K Roth (2012), “Is there an energy paradox in fuel economy? A note on the role of consumer heterogeneity and sorting bias”, Economics Letters 115(1): 44-48.

Busse, M R, C R Knittel, and F Zettelmeyer (2013), “Are consumers myopic? Evidence from new and used car purchases”, American Economic Review 103(1): 220–56.

Gillingham, K, and K Palmer (2014), “Bridging the Energy Efficiency Gap: Policy Insights from Economic Theory and Empirical Analysis”, Review of Environmental Economics & Policy 8(1): 18-38. 

Gillingham, K, S Houde, and A van Benthem (2019), “Consumer myopia in vehicle purchases: Evidence from a natural experiment”, NBER Working paper 25845. 

Grigolon, L, M Reynaert, and F Verboven (2018), “Consumer valuation of fuel costs and tax policy: Evidence from the European car market”, American Economic Journal: Economic Policy 10(3): 193-225.

Levinson, A, and L Sager (2020), “Who Values Future Energy Savings? Evidence from American Drivers”, NBER Working paper 28219.

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Topics:  Environment Microeconomic regulation

Tags:  cars, fuel savings, electric vehicles, Behavioural economics

Professor, Economics Department, Georgetown University

Assistant Professor, McCourt School of Public Policy, Georgetown University

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