Tuesday, January 4, 2011

Markets under-value fuel economy for new cars

Is it worth it to buy a fuel efficient car? If you ask an economist, he will look at the fuel consumption, the cost of gasoline, and calculate the cost benefit of a fuel efficient car, probably also factoring in a resale value and a discount rate. But a non-economist customer?

David Greene says the literature is really unclear, as customers seem to be under-valuing and over-valuing fuel efficiency depending on how you look at the data. Surveys seem to indicate that car buyers consider a very short horizon for the payback, 1.5 to 2.5 years. That makes it very difficult for fuel efficient cars, hence the need for subsidies, or better taxes on the inefficient cars (see why). But this provides little theoretical insight where car buyers differ from the economist I described above. Greene thinks this has to do with risk aversion about future gasoline prices, or loss aversion (being afraid of having taken a poor decision). But clearly, this requires more research.

Having said this, I am puzzled at how little hybrid cars have been adopted in Europe, in particular compared to the United States. The cost of European gasoline is very significantly higher, and the environmental consciousness is also more pronounced. Is it because the alternatives to hybrid cars, the small fuel efficient sedans, are much better than in the US?


Jarda said...

My parent's car in Europe (similar to a Volkswagen Passat wagon diesel, i.e. not quite a small car) routinely does 45-50 mpg on a highway at speeds around 80 mph, and you can push it close to 60 mpg with careful steady driving at speeds around 60 mph. Such cars are a tough competition for a hybrid.

David Stern said...

The answer is diesel.