Imperfect Competition, Consumer Behavior, and the Provision of Fuel Efficiency in Light-Duty Vehicles

This study explores the role of market power on the cost-effectiveness of policies to address fuel consumption. Market power gives manufacturers an incentive to under- (over-) provide fuel economy in classes whose consumers, on average, value it less (more) than in others. Adding a second market failure in consumer valuation of fuel economy, a policy trade-off emerges. Minimum standards can address distortions from price discrimination but, unlike average standards, do not provide broad-based incentives for improving fuel economy. Increasing fuel prices raises demand for fuel economy but exacerbates undervaluation and incentives for price discrimination. A combination policy may be preferred. For modelers of fuel economy policy, failure to capture consumer heterogeneity in preferences for fuel economy can lead to significant errors in predicting the distribution of effort in complying with regulation, as well as the calculation and distribution of the benefits.