Measuring the Short-Run Impact of Fuel Efficiency on U.S. Automobile Industry

Transcription

1 22 วารสารเศรษฐศาสตร ธรรมศาสตร Thammasat Economic Journal ป ท 23 ฉบ บท 1 ม นาคม 2548 Vol.23, No.1, March, 2005 Measuring the Short-Run Impact of Fuel Efficiency on U.S. Automobile Industry Abstract Supawat Rungsuriyawiboon * Since 1978 the Federal government has regulated that new fleets of all auto manufacturers selling over 10,000 cars per year in the United States reach a certain level of average fuel efficiency. The purpose of Corporate Average Fuel Efficiency (CAFÉ) standards is to lessen the national dependence on foreign oil. This paper examines the short-run impact of CAFÉ standards on the U.S. automobile industry where manufacturers can change the composition of their sales fleets by selling more small cars with higher fuelefficient and less large cars with lower fuel-efficient. In addition, this paper measures the impact of CAFÉ standards on energy consumption and on air pollution. This paper finds significant decreases on energy consumption and on air pollution in the short-run from imposing the CAFÉ standards. * The draft of this paper is prepared while the author is a research fellow at the Centre for Efficiency and Productivity Analysis (CEPA), School of Economics, University of Queensland, Australia. The author is a lecturer at Faculty of Economics, Chiang Mai University, Thailand ( sxr@eng.cmu.ac.th). The author would like to thank an anonymous referee for comments on an earlier draft. Any remaining errors are those of the author.

2 1. Introduction 23 A Corporate Average Fuel Efficiency (CAFÉ) standard program, as enacted in 1975, calls for all auto manufacturers producing more than 10,000 automobiles per year to satisfy the mandated CAFÉ level. The program establishes average mile-per-gallon (MPG) standards that apply to a manufacturer s entire fleet, rather than to the fuel-efficiency of individual models. In 1978, the Federal government has regulated the fuel economy of new cars sold in the United States to reach a certain level of average fuel efficiency. The CAFÉ levels were scheduled to rise from 18.0 MPG in 1978 to 27.5 MPG in 1985 and remain nearly constant level for all following years. The objectives of proposing CAFÉ standards are to lessen the energy consumption by automobiles and to decrease the threat of national security from imported oil. Auto manufacturers can reach higher CAFÉ standard via two methods. In the short run, manufacturers can change the composition of their sales fleets by selling more small cars with higher fuel-efficient and less large cars with lower fuelefficient. This method can be called mix-shifting. In the long run, firms can also increase the fuel efficiency of their vehicles by technological improvement. Automobiles emit several types of traditional pollutants such as volatile organic compound (VOC), nitrous oxide (NOX) and carbon monoxide (CO). These pollutants are regulated at the tailpipe with respect to miles driven. The more are fuel-efficient cars on the road, the more are miles driven. So, increasing CAFÉ standards of a car would encourage people to drive more and this would increase pollution from that car per mile. The purpose of this paper is to examine the short run (mix-shifting) effect from change in automobile fuel economy. In addition, the paper would potentially review impact of CAFÉ standards on gasoline consumption and on air pollution. Section 2 will present theoretical analysis of CAFÉ standards in a competitive framework. Section 3 will discuss about data sources. The simulation results in the automobile market used to estimate the levels of VOC, NOX and CO emissions from the imposition of CAFÉ standards would be discussed in Section 4.

3 24 2. Model Specification The paper will study reaction of automobile industry to binding CAFÉ standards in a competitive sector. The comparative static model used in this paper is an extension of Kleit (1987) model. The paper determines the base year of the model year 1999 for the analysis. Given the model year, the base number of cars sold and produced, prices of cars in each category can be determined. The system equation consists of demand and supply equations from automobile industry and a constraint from inducing CAFÉ standards. The equilibrium prices, quantities and implicit taxes will be solved under this system equation. Demand Side Automobiles sold in the market will be classified into 11 categories. There are 5 types of cars defined as small, medium, large, sport and luxury. For trucks, there are 6 types defined as small, large, small SUV, large SUV, minivan and van. The quantities sold can be defined as follow. QD = AP+B, where QD is the vector of demand quantity, P is the price vector, A is matrix of slope coefficients, and B is a vector of intercepts. Based upon the studies of Irvine (1983), Langenfeld and Munger (1985), the owncross price elasticities of demand for automobiles can be calculated by raising the price of all cars in a particular category by one percent, and determining the resulting percentage change in demand, not only in that category, but for all other categories as well. The point elasticities of demand at the original 1999 equilibrium are shown in Table 1. Supply Side The automobile industry will be divided into 4 categories of firms; three domestic firms General Motors (GM), Ford, Chrysler and Foreign companies consisting of BMW, Mercedes-Benz, and Toyota etc. The quantities produced by each firm can be defined as follow.

4 QS = C(P-T)+D, where QS is the vector of supply quantity, P is the price vector, C is matrix of slope supply coefficients, D is a vector of supply curve intercepts, and T is a vector of implicit taxes. Based upon the study reported by Friedlander et.al. (1982), the point elasticity of supply (marginal cost) in the competitive industry is given equal to 2 in the short run. Table 1: The Own and Cross Price Elasticities of Demand for Automobiles Class Demand Elasticity Table (1) Small Car (2) Medium Car (3) Large Cars (4) Sport Car (5) Luxury Car (6) Small Truck (7) Large Truck (8) Small SUV (9) Large SUV (10) Minivan (11) Van Supply Elasticity: 2.0 (all firms and classes) 25 A manufacturer who has not met the CAFÉ standard has to pay a fine. The level of the fine is set equal to fifty dollars times the difference in MPG between the CAFÉ standards and the fuel economy actually reached by the firm times the number of automobiles sold by the firm in that year. The explicit fine on a firm is equal to The estimation of the elasticity of the short-run supply curve in the automobile industry is relied on the previous studies of Friedlander et. al. (1982). In their study, they estimated the marginal cost of the automobile industry using an econometric model. For the competitive market, the short-run supply curve is defined as the marginal cost. Since the model defined in this paper is in the competitive market of the same industry, their estimated results bear the burden of support.

5 26 F = 50*(Q 1 +q 1 )*(S-MPG), MPG < S, if the firm does not reach the standard, where S is the level of the CAFÉ standard, Q 1 and q 1 are the number of large and small cars sold by the firm, and MPG is the firm s average fuel efficiency. A firm s CAFÉ level is the harmonic average of that firm s fleet MPG which is calculated by Q1 + q1 MPG =, Q1 q1 + M L M S where M L and M S are the fuel efficiencies of large and small cars respectively. Using the harmonic average, the marginal CAFÉ fine to the firm of producing a large car is F T = Q 1 2 MPG = 50 * S 2MPG +, M L if the standards are binding (S = MPG), the explicit fine of $50 per MPG is replaced by a shadow tax L and the implicit CAFÉ tax on a large car becomes F S T = = L * S * 1, Q1 M L where L is the value of the constraint mentioned above. In a competitive market with no CAFÉ standards and where consumers have perfect information and there are no transaction costs, the marginal cost of fuel efficiency should equal the returns to consumers from increased fuel efficiency. The model would impose a shadow tax on producers who are below the relevant CAFÉ standard. The shadow tax would be different for each producer who would not meet the relevant CAFÉ standard. In the short run, producers would respond to the tax by mixshifting with the marginal costs of each improvement being equal in equilibrium. The model would be iterated until equilibrium was reached where all producers met standard.

6 27 Then, the simulation will be done by increasing various CAFÉ levels. Once the CAFEinduced equilibrium is determined, the impacts on gasoline consumption and pollution will be determined. Gasoline Consumption Model Once the relevant market equilibrium has been calculated, the impact of that market equilibrium on gasoline consumption can be estimated. To calculate the total gasoline consumption that will result from changing the CAFÉ standard, the average miles driven per car are measured. The average miles driven are set equal to 12,000 miles per car for every type of vehicles in the base year Total gasoline consumption can be calculated as follow. 12,000* Qi Gi =, MPG m TG = Gi, i where G i is gasoline consumption of type i car, MPG i is fuel efficiency (miles per gallon) of type i car and TG is total gasoline consumption of automobile industry. Pollution Model CAFÉ standards have important consequences for emissions of traditional pollutants, volatile organic compounds, nitrous oxide and carbon monoxide (VOC, NOX, and CO) from automobiles. These pollutants are regulated by the Environmental Protection Agency (EPA) on a per mile basis. Thus, if CAFÉ standards increase miles driven, they can be expected to increase emissions of traditional pollutants. To model pollution emission, one must measure the emissions per mile by model year and vintage. Rate per miles of three pollutants VOC, NOX and CO is measured at the tailpipe. The levels of pollution regarding on VOC, NOX and CO are calculated by i

7 28 Pollution = RPM * MD Q, i i * where RPM i is rate per miles of i pollutants, MD is miles driven by car in the base year, Q is total quantities of cars sold. 2.1 Base Case Model The paper determines the base year model as of CAFÉ standards call for a fine of $50 per car-mpg to be assessed to firms that do not meet the standard. Domestic firms (GM, Ford, Chrysler) have always asserted that they are unable to pay a fine. Therefore, the standard is modeled as binding on them. Foreign firms, however, appear to view the fine as equivalent to a tax. Several foreign firms with relatively small volumes have paid this tax to the Federal government. The larger foreign firms, however, have more fuel efficient vehicles and have not been bound by CAFÉ standards. This model, therefore, treats the foreign sector as unbound by CAFÉ standards. In the short run, the model is run to induce a 1.5 MPG increase in the fuel economy average for both cars and trucks, above the actual 1999 level, from binding domestic firms while unbinding foreign firms will choose to pay for a fine. Data on initial condition of the actual 1999 level are presented in Table Sensitivity Model The sensitivity model is run with an MPG increase by 0.3 in the fuel economy average for both cars and trucks, above the actual 1999 level, from GM, Ford, and Chrysler. The sensitivity analysis will continue until the CAFÉ standards are increased by 1.5 from the actual 1999 level for both cars and trucks. Then, total gasoline consumption and the pollution emissions of VOC, NOX and CO will be determined and compared to the actual 1999 level.

8 Table 2: Initial Condition - Model Year 1999 Initial MPG by Firms Initial Quantities by Firms Class (miles per gallon) (millions of units) GM Ford Chrysler Foreign GM Ford Chrysler Foreign (1) Small Car (2) Medium Car (3) Large Cars (4) Sport Car (5) Luxury Car (6) Small Truck (7) Large Truck (8) Small SUV (9) Large SUV (10) Minivan (11) Van Initial Totals by Class Initial Profit by firms Class Prices Quantity (in billions) MPG ($000) (million) GM Ford Chrysler Foreign (1) Small Car (2) Medium Car (3) Large Cars (4) Sport Car (5) Luxury Car (6) Small Truck (7) Large Truck (8) Small SUV (9) Large SUV (10) Minivan (11) Van

9 30 3. Data Sources Data on prices, demand and supply quantities are obtained from an assistance of the General Motor Company. Data on miles driven and fuel efficiency (MPG) are obtained from the Federal Highway Administration WebPages ( Emission rates by model year and vintage of VOC, NOX and CO are obtained from Air Improvement Resources WebPages ( 4. Empirical Results 4.1. Short Run Model Results The results from increasing MPG by 1.5 in the fuel economy average for both cars and trucks, above the actual 1999 level are presented in Table 3. Shadow taxes needed to induce a 1.5 MPG change in U.S. firms range from a low of $1,615 per MPG for Ford cars to a high of $3,986 for Chrysler trucks. Raising the domestic firms MPG by 1.5 MPG results in a market substitution effect from foreign (unconstrained) firms. For example, because CAFÉ standards reduce luxury car sales from the three constrained firms, they increase profit opportunities in that sector for unconstrained firms. The net result, across the entire market, is that car MPG increase 0.68 miles per gallon, truck MPG increase by 1.30 miles per gallon. Table 3: The Effects of a CAFÉ (MPG Increase = 1.5) Type Initial MPG New MPG GM Ford Chrysler Foreign GM Ford Chrysler Foreign Cars Trucks Type Shadow Tax ($ per MPG) GM Ford Chrysler Foreign Cars Trucks Data used in this study are available upon the request.

10 Table 3: The Effects of a CAFÉ (MPG Increase = 1.5) (Continue) 31 Totals by Class Change from Initial Class Prices Quantity Prices Quantity ($000) (million) MPG ($000) (million) MPG New Output by Firms Change of Output by Firms Class (millions of units) (millions of units) GM Ford Chrysler Foreign GM Ford Chrysler Foreign New Profit by Firms Change of Profit by Firms Class (in billions) (in billions) GM Ford Chrysler Foreign GM Ford Chrysler Foreign Total

11 32 The results from mix-shifting in the short run indicate that firms will increase the sales of small car, small truck and minivan which have high fuel efficiency by 0.588, and millions respectively. Total sales of cars and trucks are decreased by millions. Prices of small car, small truck and minivan are reduced by $1233, $714 and $2255 respectively. Domestic firms profits will be decreased by the short-run impact of CAFÉ regulations. The gains will be transferred to foreign firms because of increasing quantities sold. The profits of GM, Ford, and Chrysler will be decreased by 12.66, 12.89, and 9.33 billions respectively while the profits of foreign firms will be increased by billions as a result of increasing CAFÉ standards by 1.5 from the actual 1999 level in the short run. The impacts of a higher short-run CAFÉ standard on pollution emissions and gasoline consumption are presented in Table 4. Short-run increases in CAFÉ can be expected to reduce pollution because they reduce the number of cars on the road. Emissions of VOC, NOX and CO would reduce by 45.06, and million kilograms respectively after increasing CAFÉ standards by 1.5 from the base year model. In other words, emissions actually decrease by 0.45% for VOC, 0.36% for NOX and 3.86% for CO. The gasoline consumption declines by billion gallons, or reduces by 11.64%. Table 4: The Impacts of CAFÉ Standards on Pollution Emissions and Gasoline Consumption (CAFÉ Increase = 1.5) Pollution Impacts (all in million kilograms) VOC NOX CO Original level of emissions before CAFÉ imposed , Level of emissions after CAFÉ increased by , Saving level of emissions Percent Change % % % Gasoline Consumption Initial Gasoline Consumption before CAFÉ imposed (in billion gallons) New Gasoline Consumption after CAFÉ increased by Saving level of Gasoline Consumption Percent Change %

12 4.2. Sensitivity Model Results The gasoline consumption results are summarized in Figure 1. The simulation was run with various CAFÉ MPG levels. The results yield that gasoline consumption will be reduced in every run which CAFÉ increases by 0.3. There is no a perverse effect from saving gasoline consumption. Kwoka (1983) hypothesized that CAFÉ standards could increase gasoline consumption by placing more cars on the road. The short-run impact from mix-shifting has indicated that total quantities of vehicles sold are decreased. The reduction of total sales of low fuel efficiency cars would offset an increase of small cars with high fuel efficiency. As this result, the gasoline consumption would decrease as the increase of CAFÉ standards in the short-run. 33 Figure 1: Gasoline Saving From CAFE Gasoline Savings (Billion Gallons) CAFE Standards Increased from Original MPG

13 34 Table 5 presents the impact on air pollution from increasing CAFÉ standards by 0.3 in each run. Emissions of VOC and NOX are decreased after increasing CAFÉ standards by 0.6 while emissions of CO are decreased after CAFÉ standard is increased by 0.3. Short-run increases in CAFÉ can reduce pollution because they reduce the number of cars and trucks sold. As the result of less number of cars on the road, this would reduce the air pollution. Figure 2-4 plot the emission levels of VOC, NOX and CO when CAFÉ standards are increased by 0.3 each run until they are satisfied a certain level of average fuel efficiency in the short run (CAFÉ standards are increased by 1.5). Table 5: (Simulation Results ) The Impact of CAFÉ Standards on Pollution Emission Pollutants Original Level 0.3 % Change 0.6 % Change Pollution Impacts (all in million kilograms) CAFÉ Standards Increased By 0.9 % Change 1.2 % Change 1.5 % Change VOC NOX CO 5,289 5, , , , ,

14 35 Figure 2: The Impact of CAFE on VOC Emission 660 million kilograms CAFE Standard Increased from Original MPG Figure 3: The Impact of CAFE on NOX Emissions million Kilograms CAFE Standard Increased from Original MPG Figure 4: The Impact of CAFE on CO Emissions million kilograms CAFE Standard Increased from Original MPG

15 36 5. Conclusion A 1.5 MPG short-run increase in both car and truck CAFÉ standards decreases total sales of cars and trucks by millions. GM profits decline by $12.66 billions, Ford by $ billions, and Chrysler by $9.33 billions while foreign firms profits increase by $22.64 billions. As a result of total sales of cars and trucks decreased, gasoline consumption declines by billion gallons, or saved by 11.64% from the original level. Emissions of VOC, NOX and CO reduce by 45.06, and million kilograms respectively. In other word, emissions actually decline by 0.45% for VOC, 0.36% for NOX and 3.86% for CO. The sensitivity results from increasing CAFÉ standards by 0.3 in each run until CAFÉ standards increase by 1.5 from the base year model yield to saving of gasoline consumption in every run. There is no a perverse effect from saving gasoline consumption. There is, however, a perverse effect on impact of emissions. Emissions of VOC and NOX are decreased after increasing CAFÉ standards by 0.6 while emissions of CO are decreased after CAFÉ standard is increased by 0.3. The extensions of this paper are to model and estimate the impacts on welfare economics and the impact on safety. The long-run model from technological improvement can be modeled and compared to the results of the short-run model in this paper. The scrappage effect (the change in the stock of used cars that results from a change in the price of new cars) can be considered and included in order to determine the total stock of cars in operation. As of including the scrappage effect, the stock effects of gasoline consumption and pollutions can be calculated and added into a base year model of 1999 to estimate total impacts on gasoline consumption and pollutions.

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