Blog Post

How Do Gasoline Prices Affect New Vehicle Sales?

Feb 3, 2016 | Benjamin Leard, Joshua Linn

At an RFF First Wednesday Seminar, The Evolving US Vehicle Fleet: Responding to New Federal Regulations, we gathered various experts to discuss key issues related to trends in the evidence regarding the efficiency and effectiveness of the new Corporate Average Fuel Economy (CAFE) standards. Several of these issues will be examined as part of this blog series, Evidence for the New CAFE Standards.

Over the past year we’ve seen a sudden drop in gasoline prices and many news stories about the ensuing reversal in new vehicle fuel economy. Before mid-2014, gas prices were often well above $3 per gallon (high by historical standards). Prior to the price drop, the average fuel economy of new vehicles had been rising (largely because of the tightening fuel economy standards). Following the drop in global oil prices, gasoline prices also dropped. Today, gas can be found below $2 per gallon in much of the country, saving a typical household close to $1,000 annually. And between 2014 and 2015—the same time that gasoline prices fell—new vehicle fuel economy stopped increasing and actually dropped.

At RFF an First Wednesday Seminar in December 2015, we presented the results of our recent paper in which we ask whether low gas prices mean the end of rising fuel economy. We find that, notwithstanding the recent news stories, the effect of gas prices on new vehicle market shares has actually diminished. Moreover, we do not find evidence that low gas prices will reduce the overall level of fuel economy by a large amount if the fuel economy requirements remain as they are.

The first question is: How do gas prices affect new vehicle sales (or market shares)? Several studies have demonstrated a strong link between gasoline prices and market shares, particularly when gas prices were high or rising. For example, between 2003 and 2007, rising gasoline prices explain about half of the shift from large sport utility vehicles (SUVs) to smaller crossovers. But in the past few years gas prices have been high and relatively volatile. We examined whether the effect of gasoline prices on market shares was different over this period of time, finding that although recent changes in gas prices have had substantial effects—including a reverse of the previous trend of falling SUV market shares—the effects were smaller than they were in the mid-2000s when gas prices were rising. We find some evidence that new vehicle sales respond more to rising prices rather than falling prices, but the underlying reasons why falling gas prices have had a smaller effect remain an open question.

In our study, we were particularly interested in how gas prices interact with fuel economy standards. We find, first, that fuel economy standards tend to reduce the sensitivity of market shares to gas prices. Consider a hypothetical manufacturer facing a fuel economy standard. To meet the standard, the manufacturer can add technology to boost the fuel economy of the vehicles it sells, and it can also adjust vehicle prices to encourage consumers to purchase vehicles with relatively high fuel economy. Theory and evidence show that manufacturers actually use both approaches to meet fuel economy standards. But it’s complicated: if the manufacturer does not change vehicle prices when gas prices drop, the lower gas prices would make vehicles with low fuel economy more attractive to consumers, increasing their sales. This would cause the manufacturer to fall short of meeting its standard. Therefore, to meet the standard when gas prices are low, the manufacturer would readjust its vehicle prices so that market shares return to their initial levels—in effect, undoing the effects of the gas price decrease. Following this logic we would expect fuel economy standards to reduce, if not eliminate, the effects of gas prices on market shares. Using proxies for the stringency of the standards, we find evidence that more stringent standards continue to reduce the effect of gas prices on market shares.

The second interaction between gas prices and market shares is that a drop in gas prices could reduce the overall level of fuel economy required by the standards. Each vehicle in the market faces a fuel economy requirement that depends on its footprint—roughly, the area defined by the four wheels. Smaller vehicles have to achieve a higher level of fuel economy than do larger vehicles. This structure implies that each manufacturer faces a different fuel economy standard that depends on the mix of vehicles it sells; manufacturers selling large vehicles have a lower standard than manufacturers selling small vehicles. The structure also implies that if low gas prices induce a shift in sales to larger vehicles, the fuel economy standard each manufacturer faces will go down. As a result, we would expect low gas prices to imply lower fuel economy standards, and lower fuel savings caused by the overall program. We do find evidence of this effect, but it is small, implying that the recent gas price drop reduced the fuel economy requirement by about 0.1 mile per gallon. This decrease erodes about 14 percent of the increase in stringency of the standards between 2014 and 2015, but erodes only about 4 percent of the actual fuel economy increase between 2011 and 2014.

Up next in the series: Emerging Evidence on the CAFE Credit Trading Program

Read previous posts in this RFF blog series, Evidence for the New CAFE Standards:

  1. The New CAFE Rules and the Need for Evidence from the Field