New Vehicle Characteristics and the Cost of the Corporate Average Fuel Economy Standard

By 2016, the Corporate Average Fuel Economy (CAFE) standard will increase by 40 percent from its current level, representing the first major increase in the standard since its creation in 1975. Previous analysis of the CAFE standard has focused on its short-run effects (1–2 years), in which vehicle characteristics are held fixed, or its long run effects (10 years or more), when firms can adopt new power train technology. This paper focuses on the medium run, when firms can choose characteristics such as weight and power, yet have only limited ability to modify current technology. We first document the historical importance of the medium run and then estimate consumers’ willingness to pay for vehicle characteristics. We employ a novel empirical strategy that accounts for the vehicle characteristics’ endogeneity by using variation in the set of engine models used in vehicle models. The results imply that consumers value an increase in power more than a proportional increase in fuel economy. Simulations of the medium-run effects of an increase in the CAFE standard suggest that regulatory costs are significantly smaller in the medium run than in the short run.