CAFE OR PRICE?: An Analysis of the Effects of Federal Fuel Economy Regulations and Gasoline Price on New Car MPG, 1978-89

Following a tripling of world oil prices in 1973-74, the U.S. Congress passed the Energy Policy and Conservation Act of 1975 establishing mandatory fuel economy standards for automobiles and light trucks. Beginning at 18 MPG in 1978, the passenger car standards increased to 27.5 MPG by 1985. There has been considerable debate about the influence of the standards, as opposed to the gasoline price increases in 1973-74 and 1979-80, on new car fuel economy. Twelve years of average fuel economy data are now available for every manufacturer’s domestic and imported car fleets, making possible a statistical estimation of the relative importance of standards versus fuel prices in determining new car MPG. In this paper a penalty function is formulated in which deviations from either the standard or the market equilibrium demand for fuel economy create costs for manufacturers. An equation for new car MPG is derived by minimizing the sum of quadratic penalty functions. Estimation of the model, using 15 sets of manufacturer CAFE data for 1978-89, clearly indicates that the CAFE standards were a significant constraint for many manufacturers, and were perhaps twice as important an influence as gasoline prices. A test for structural change in the model does not reject the hypothesis that the CAFE constraint had the same effect on carmakers before and after 1983.