Although economic theory suggests that market size and fuel costs affect fuel-saving technology adoption by vehicle manufacturers, there is very little empirical evidence. We document a strong connection between market size, as measured by a vehicle’s sales, and technology adoption. Using a demographics-driven demand shifter to instrument for market size, we find that a 10 percent increase in market size raises power train efficiency by 0.2 percent, compared with a mean improvement rate of 1.4 percent per year between 1997 and 2013. Higher fuel prices affect technology adoption directly by influencing willingness to pay for fuel cost savings, and indirectly by influencing market size. The results have two implications: policies promoting alternative-fuel vehicles will be less effective than previously thought; and fuel taxes have different effects on technology adoption than do fuel economy standards and feebates.
- Based on US data from 1997–2013, a 10 percent increase in market size (sales) raises vehicle efficiency by 0.3 percent.
- Fuel prices and demographics have had substantial effects on technology adoption in the US market.
- The market size effect introduces a challenge for alternative fuel vehicles competing with gasoline-powered vehicles, which currently dominate the US market.
- Because of the market size effect, fuel economy standards, fee-bates, and fuel taxes reduce the efficiency of low-selling vehicles.