WEAI/AERE 2009 - Individual Paper Abstract
Title: CAFE regulation: The downside of double standards
Author(s): Emma HUTCHINSON, Department of Economics, University of Victoria, Victoria, BC V8W 2Y2 Canada, ehutchin@uvic.ca (250) 472-4412 (picture credit: Smart Car, Thessaloniki EAERE 2007, TAC)
Abstract:
Current policy debate about automotive-sector regulation in North America is occurring in the face of two seemingly opposing concerns. One the one hand, the dire financial position of manufacturers has led some to argue that the environmental regulatory burden on auto companies should not be increased. On the other hand are arguments that improvements in automotive fuel efficiency are an essential component of climate change policy. In the context of the current financial crisis, many believe that the environment will end up taking a back seat, as all efforts are made to ensure the survival of the automotive industry. This paper uses a simple model of product differentiation to make the case that there may exist a regulatory change that will achieve improvements in both environmental quality related to automotive fuel efficiency, and the profitability of auto manufacturers. This regulatory change is the replacement of the current dual fuel efficiency standard (as laid out in current CAFE regulations) with a single standard to be met across the entire fleet of vehicles.
Existing CAFE regulations impose one (more stringent) standard for passenger vehicles and a second (less stringent standard) for light trucks. To be in compliance, an auto manufacturer’s sales-weighted average fuel efficiency must meet the standards in both categories of vehicles. If an auto-manufacturer’s sales are such that fuel efficiency is lower than the standard in both categories of vehicles, there currently exist two different mechanisms to ensure compliance.
The first is to alter the sales mix within each category; that is, by inducing consumers of passenger vehicles to buy smaller passenger vehicles and inducing consumers of light trucks to buy smaller light trucks. In addition to ensuring compliance, this will increase the fuel efficiency of the aggregate fleet of vehicles (i.e., it will increase the average fuel efficiency in both classes), and hence improves environmental quality, relative to the case of noncompliance.
The second method to ensure compliance is to alter the sales mix across the two classes; that is, by inducing consumers of large passenger vehicles to instead buy small light trucks. This second method will actually reduce the fuel efficiency of the aggregate fleet, and hence lower environmental quality. Note that – were a single fuel efficiency standard to be imposed across both class of vehicles – this perverse effect on environmental quality would not be possible.
The extent to which auto manufacturers rely on the second method over the first, and the overall welfare effects of doing so, will of course depend on parameter values of the model, including the distribution of consumer preferences and firms’ costs of production. In the paper, I explore the circumstances under which we might expect this perverse effect on aggregate fuel efficiency as well as describe the circumstances under which a single fuel efficiency standard applied across the entire fleet of vehicles will be welfare-dominate the current dual standard.