A Study of Fuel Efficiency and Emission Policy Impact on Optimal Vehicle Design Decisions

Recent environmental legislation, such as the European Union Directive on End-ofLife Vehicles and the Japanese Home Electric Appliances Recycling law, has had a major influence on product design from both an engineering and an economic perspective. This article presents a methodology for studying the effects of automobile fuel efficiency and emission policies on the long-term design decisions of profit-seeking automobile producers competing in an oligopoly market. Mathematical models of engineering performance, consumer demand, and manufacturing costs are developed for a specific market segment, and game theory is utilized to simulate competition among firms to predict design choices of producers at market equilibrium. Several policy scenarios are evaluated for the small car market, including corporate average fuel economy (CAFE) standards, carbon dioxide (CO2) emissions taxes, and diesel technology quotas. The results indicate that leveraging CO2 taxes on producers for expected life cycle emissions yields diminishing returns on fuel efficiency improvement per regulatory dollar as the taxes increase, while CAFE standards achieve higher average fuel efficiency per regulatory dollar. Results also indicate that increasing penalties for violation of CAFE standards can result in lower cost to producers and consumers because of the effects of competition, and penalties based on fuel economy or emissions alone may not be sufficient incentive for producers to bring more costly alternative fuel vehicles into the market. The ability to compare regulations and achieve realistic trends suggest that including engineering design and performance considerations in policy analysis can yield useful predictive insight into the impact of government regulations on industry, consumers, and the environment. WORKING PAPER SERIES A Study of Fuel Efficiency and Emission Policy Impact on Optimal Vehicle Design Decisions