Gasoline Prices, Fuel Economy, and the Energy Paradox

Abstract

It is often asserted that consumers undervalue future gasoline costs relative to purchase prices when they choose between automobiles, or equivalently that they have high "implied discount rates" for these future energy costs. We show how this can be tested by measuring whether relative prices of vehicles with different fuel economy ratings fully adjust to time series variation in gasoline price forecasts. We then test the model using a detailed dataset based on 86 million transactions at auto dealerships and wholesale auctions between 1999 and 2008. Over our base sample, vehicle prices move as if consumers are indifferent between one dollar in discounted future gas costs and only 76 cents in vehicle purchase price. We document how endogenous market shares and utilization, measurement error, and different gasoline price forecasts can affect the results, and we show how to address these issues empirically. We also provide unique empirical evidence of sticky information: vehicle markets respond to changes in gasoline prices with up to a six month delay.