The Moderating Effect of Fuel Prices on the Market Value of Fuel Economy, Driving Intensity, and CO2 Emissions

Abstract

In this paper, we explore co-movements of the vehicle price sensitivity to fuel economy with changes in fuel prices. Previous literature has investigated the responsiveness of vehicle prices to fuel prices or fuel economy. We are interested in the interaction effect of fuel prices and fuel economy and answer the question of how exactly the market value of fuel economy depends on the fuel price. By looking at the role of fuel prices as a moderator for the market value of fuel economy, we are able to differentiate between consumers’ valuation of fuel economy versus their reaction to changes in fuel prices. We apply a hedonic price model to the German automobile market by using data on detailed technical specifications of high-sales vehicles of three consecutive model years. In contrast to previous research, where the marginal benefits of driving a car with a particular fuel economy remained constant, we allow it to vary with fuel prices. It enables us to investigate two sources of changes in the market value for fuel economy. The first source, as in the previous studies, corresponds to changes in the budget for driving a car, whereas the second source reflects changes in the capital investments in a better fuel economy. The total effect of these two sources may lead to either a decrease or an increase in the vehicle distance traveled. We study the differences in the impact of fuel prices for various car makes of both diesel and gasoline engines. Our results suggest that there are substantial differences in the market values of fuel economy between diesel and gasoline vehicles and their responsiveness to changes in fuel prices. Diesel cars are characterized by the more elastic price gradient of fuel economy to fuel prices compared to gasoline cars. The revealed high responsiveness of the market value of fuel economy to fuel prices results in an optimal annual driving intensity that is an increasing function of fuel prices. It implies that, during the period of investigation, the marginal benefit of driving a car of a specific fuel economy was higher than the corresponding fuel price effect on the budget for driving. Using the quantified impact of fuel prices on the market value of fuel economy, we also assess the implied changes in the kilometers driven with cars and the resulting CO2 emissions. The current study presents an empirical application of statistical analysis to a topic of interest to readers in the areas of quantitative economics and economic policy.