Increasing Fuel Prices And The Need For Better Fuel Economy

Running Head: Increasing Fuel Prices and the Need for Better Fuel Economy

Microeconomics

August 30, 2006

Abstract

American's love their sport utility vehicles and big gas guzzling performance engines. However, with the recent increases in fuel prices, increased global oil demand, and the concern for Global Warming, we need to identify how to increase the fuel economy of our vehicles. Congress attempted to increase vehicle fuel economy in the 1970's with the creation of the corporate average fuel efficiency (CAFE) standards for passenger cars and light trucks. However the CAFÐ"‰ standards have not been changed in over 25 years. Perhaps it is time to re-evaluate how to promote fuel efficiency.

American's love their heavy, large and high performance vehicles. Over the past two decades these vehicles have become very popular and consumers have been willing to pay the increased fuel costs associated with these fuel inefficient vehicles.

The choice of consumers to operate fuel inefficient vehicles have significantly contributed to our nations dependency on oil, which in turn has made our nation more dependent on oil produced in unstable foreign regions. In the past few years it has also become evident that the increased oil consumption is contributing to the Global Warming phenomena. With the increased global demand on oil supplies and the recent spiking of oil prices, it is now apparent that we must find away to make our vehicles more fuel efficient.

After the oil embargo of the 1970's Congress passed the Energy Policy Conservation Act which created the corporate average fuel efficiency (CAFE) standards for passenger cars and light trucks. As a result of the CAFÐ"‰ standards fuel efficiency amongst vehicles rose significantly between 1976 and the 1980's. Fuel efficiency peaked between 1987-1988 at 22.1 miles per gallon (Environmental Protection Agency, 2006). The average fuel efficiency has remained fairly stable since 1987. In 2006 the average fuel efficiency is 21 miles per gallon (fuel efficiency dropped between 1987 and 2006). Since 1987, it appears that the domestic auto manufacturers effectively abandoned their aspirations for making vehicles more fuel efficient. However, we cannot blame the auto manufacturers for this abandonment. The auto manufacturers met public demand for heavier, more powerful vehicles. During this time period the consumer buying habits seem to indicate that consumers were not concerned with fuel economy, but rather demanded heavier, more powerful vehicles. In a study, the EPA said that the 2006 model-year vehicles are the heaviest, fastest and most powerful vehicles than in any year since the agency began collecting data in 1975. The Alliance of Automobile Manufacturers indicated that even though the industry is "building more vehicles with fuel-saving technology, consumers are still buying heavier, faster vehicles in large numbers" (Freeman, 2006). We cannot fault the auto industry for catering to consumers demand. It is also important to note the significant contribution by the consumer to annual fuel economy trend data. "The government's mileage ratings and standards are sales-weighted. That means they are based on the average fuel economy of vehicles sold" (Brown, 2006). This also means that consumer demand plays a significant role in the annual fuel economy trends. If the fuel efficient vehicles remained in the dealer lots (unsold), they would have no effect on the annual fuel economy trend. The concept of the CAFÐ"‰ standard was very sound and was effective for a short time. However Congress made no provision to make fuel efficient vehicles more desirable (which would increase demand).

Congress only has two basic means for increasing fuel economy. Congress could intervene to alter demand or alter supply. Congress chose to alter supply. Altering the supply via the CAFÐ"‰ standard only inconvenienced the auto manufacturers. If Congress had chosen to alter demand they would have inconvenienced the consumers (voting public). Politically, the CAFÐ"‰ standard was a great way for Congress to increase fuel economy.

Since the CAFÐ"‰ standards no longer seem to be effective, maybe its time to identify avenues for improving fuel economy.

Congress could provide incentives for consumers to move to more fuel efficient vehicles. For instance, aggressive tax deductions may provide consumers the incentive (which affects demand) to purchase more fuel efficient vehicles. Congress already has a similar "Clean-Fuel" vehicle tax deduction.

Congress could impose an engine displacement and horsepower tax on new vehicles which would lower the demand for the inefficient vehicles.

Congress could re-impose the 55 mile per hour speed limit, which would reduce fuel consumption. However, it can be argued that reducing the speed limit would not necessarily improve fuel economy as it is not Ceteris paribus. I also do not like this option as it would not necessarily encourage the manufacturers to improve fuel economy.

We could let free market dictate supply and demand without intervention. As gas prices continue to climb, demand for fuel inefficient