Automobile Prices, Gasoline Prices, and Consumer Demand for Fuel Economy

The relationship between gasoline prices and the demand for vehicle fuel efficiency is important for environmental policy but poorly understood in the academic literature. We provide empirical evidence that automobile manufacturers price as if consumers respond to gasoline prices. We derive a reduced-form regression equation from theoretical micro-foundations and estimate the equation with nearly 300,000 vehicle-week-region observations over the period 20032006. We find that vehicle prices generally decline in the gasoline price. The decline is larger for inefficient vehicles, and the prices of particularly efficient vehicles actually rise. Structural estimation that ignores these effects underestimates consumer preferences for fuel efficiency.