Network Effects in Alternative Fuel Adoption: Empirical Analysis of the Market for Ethanol
AbstractThis paper investigates the importance of network effects in the demand for ethanol-compatible vehicles and the supply of ethanol fuel retailers. An indirect network effect, or positive feedback loop, arises in this context due to spatially-dependent complementarities in the availability of ethanol fuel and the installed base of ethanol-compatible vehicles. Marketers and social planners are interested in whether these effects exist, and if so, how policy might accelerate adoption of the ethanol fuel standard within a targeted population. To measure these feedback effects, I develop an econometric framework that considers the simultaneous determination of ethanol-compatible vehicle demand and ethanol fuel supply in local markets. The demand-side of the model considers the automobile purchase decisions of consumers and fleet operators, and the supply-side model considers the ethanol market entry decisions of competing fuel retailers. I propose new estimators that address the endogeneity induced by the co-determination of alternative fuel vehicle demand and alternative fuel supply. I estimate the model using zip code level panel data from six states over a six year period. I find the network effect to be highly significant, both statistically and economically. Under typical market conditions, entry of an additional ethanol fuel retailer leads to a 12% increase in consumer demand for ethanol-compatible vehicles. The entry model estimates imply that a monopolist requires a local installed base of at least 204 ethanol-compatible vehicles to be profitable. As an application, I demonstrate how the model estimates can inform the promotional strategy of a vehicle manufacturer. Counterfactual simulations indicate that subsidizing fuel retailers to offer ethanol can be an effective policy to indirectly increase ethanol-compatible vehicle sales.
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Bibliographic InfoPaper provided by NET Institute in its series Working Papers with number 10-20.
Length: 60 pages
Date of creation: Oct 2010
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ethanol; flex-fuel vehicles; indirect network e¤ects; market entry;
Find related papers by JEL classification:
- C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models
- C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
- D12 - Microeconomics - - Household Behavior - - - Consumer Economics: Empirical Analysis
- D22 - Microeconomics - - Production and Organizations - - - Firm Behavior: Empirical Analysis
- L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms
- L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation
- L91 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Transportation: General
- M31 - Business Administration and Business Economics; Marketing; Accounting - - Marketing and Advertising - - - Marketing
- O32 - Economic Development, Technological Change, and Growth - - Technological Change; Research and Development; Intellectual Property Rights - - - Management of Technological Innovation and R&D
- Q21 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Renewable Resources and Conservation - - - Demand and Supply; Prices
- Q42 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Alternative Energy Sources
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-10-09 (All new papers)
- NEP-ENE-2010-10-09 (Energy Economics)
- NEP-NET-2010-10-09 (Network Economics)
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