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"Fuel Economy: The Case for Market Failure" a chapter in Reducing Climate Impacts in the Transportation Sector

UCD-ITS-RP-09-71

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The efficiency of energy using durable goods, from automobiles to home air conditioners, is not only a key determinant of economy-wide energy use but also of greenhouse gas (GHG) emissions, climate change and energy insecurity. Energy analysts have long noted that consumers appear to have high implicit discount rates for future fuel savings when choosing among energy using durable goods (Howarth and Sanstad, 1995). In modeling consumers’ choices of appliances, the Energy Information Administration (EIA) has used discount rates of 30 percent for heating systems, 69 percent for choice of refrigerator and up to 111 percent for choice of water heater (U.S. DOE/ EIA, 1996). Several explanations have been offered for this widespread phenomenon, including asymmetric information, bounded rationality and transaction costs.

This chapter argues that uncertainty combined with loss aversion by consumers is sufficient to explain the failure to adopt cost effective energy efficiency improvements in the market for automotive fuel economy, although other market failures appear to be present as well. Understanding how markets for energy efficiency function is crucial to formulating effective energy policies (see Pizer, 2006). Fischer et al., (2004), for example, demonstrated that if consumers fully value the discounted present value of future fuel savings, fuel economy standards are largely redundant and produce small welfare losses. However, if consumers value only the first three years of fuel savings, then fuel economy standards can significantly increase consumer welfare. The nature of any market failure that might be present in the market for energy efficiency would also affect the relative efficacy of energy taxes versus regulatory standards (CBO, 2003). If markets function efficiently, energy taxes would generally be more efficient than regulatory standards in increasing energy efficiency and reducing energy use. If markets are decidedly inefficient, standards would likely be more effective.

Suggested Citation: D. L. Greene, J. German, and M. A. Delucchi, “Fuel Economy: The Case for Market Failure,” Chapter 11 of Reducing Climate Impacts in the Transportation Sector, edited by D. Sperling and J. S. Cannon, Springer, pp. 181-205 (2009).