Discussion Paper

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

Dec 13, 2010 | Thomas Klier, Joshua Linn


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.

From its inception in the late 1970s, Corporate Average Fuel Economy (CAFE) standards reduced the weight and power of vehicles on American roads in order to increase fuel economy. Now, with CAFE standards expected to increase by 40 percent by 2020, observers are wondering how much the changes will cost and how consumers will react to an increase in fuel economy.

Previous analytical models have looked at the short run (one to two years), using price changes to adjust to standards, and the long-run (10 years and over), when there was time for a large technology overhaul. In New Vehicle Characteristics and the Cost of the Corporate Average Fuel Economy Standard, Thomas Klier and Joshua Linn assess the medium run. Manufacturers redesign vehicles every four to five years, altering weight, power, and fuel economy to meet the new CAFE standards. The authors discover that in this model, modifications are indeed less costly than short-term adjustments to the sales mix. Will consumers pay for this increase in fuel economy? Klier and Linn find that consumers value an increase in power over an increase in fuel economy.