The Energy Efficiency Gap in Transportation

Source Title: 
The U-M Energy Institute

This report is authored by U-M Department of Economics PhD student Alecia Cassidy. The energy efficiency gap is the failure of consumers or producers to make energy efficiency investments that would seemingly save money or increase profits. The phenomenon is important to understand, because if it exists and reflects irrational decisions on the part of consumers or firms, then policy intervention might be warranted. 

This report examines evidence for the energy efficiency gap in the automobile industry, and ultimately finds that the evidence is inconclusive. Three general approaches were employed: survey research, reduced-form analysis, and discrete choice modeling. Survey research finds evidence of an energy efficiency gap. Reduced-form analyses find no energy efficiency gap. The results of discrete choice models differ, with some finding evidence of an energy efficiency gap and others finding no evidence. 

Despite the uncertain existence of the energy efficiency gap in transportation, a growing body of literature focuses on explanations for it. Explanations for why consumer decisions might exhibit an energy efficiency gap include: 

  • Consumers face uncertainty in miles per gallon (MPG) and fuel prices, and might view an upgrade to a more fuel-efficient car as risky. Because of this, they may delay their purchase of a new, energy-efficient vehicle because they have the option of waiting to invest in fuel efficiency at a later date. 
  • Researching fuel efficiency of vehicles before purchasing a new car takes time and energy. What seems like a suboptimal fuel economy decision on the part of a consumer might be rational inattention. 
  • Consumers might systematically miscalculate their future fuel costs, for example if they falsely believe that gasoline consumption decreases as a linear function of a car’s MPG. 
  • Consumers face trade-offs between fuel economy and other vehicle attributes. They do not have a choice between different fuel economies, holding all other vehicle attributes fixed. Thus, what seems to be undervaluation of fuel economy might simply be preference for other vehicle attributes. 
  • Consumers might delay investment in fuel-efficient vehicles because they wish to learn more about these vehicles from the experience of other consumers. 
  • Credit constraints might prevent consumers from investing in additional fuel economy. 
  • Mistrust of fuel economy estimates might lead consumers to ignore fuel economy when making purchases. 

This report explores the following explanations for why producers might not provide energy efficiency even when consumers demand it: 

  • Uncertainty about future technological progress, demand, and implementation costs might cause firms to “wait and see” before installing energy-efficient technology, even when that technology would seem to be profitable. 
  • Automakers might lack the ability to respond to demand for fuel economy quickly enough, for example because of multiyear design cycles.

Producers tailor vehicle attributes like fuel economy to certain segments of the market to make more profit, which might mean that for segments of the market that value fuel economy less, they provide even less fuel economy than consumers desire. 

The literature provides a diverse set of policy recommendations to rectify the energy efficiency gap. The most important finding is that policies need to “target” consumers most subject to the distortions that could cause the energy efficiency gap. For example, if low-income consumers are more likely to undervalue fuel economy and the chosen policy instrument is a tax credit, there should be income restrictions on eligibility. Policy prescriptions can be tailored to certain explanations of the energy efficiency gap. For example, if producers undersupply fuel economy in the low fuel efficiency segment of the market in order to price discriminate, then minimum standards are more likely to result in the desired outcome. This is because standards directly raise the fuel efficiency of the least fuel-efficient products. It is worthwhile to note that certain explanations for the energy efficiency gap might not warrant intervention. 

The issue of whether or not an energy efficiency gap exists is still an open question. Future work might focus on understanding which explanation of the energy efficiency gap is most likely and examining the effectiveness of information provision policies. 

Understanding how consumers make fuel efficiency decisions is vital to policy. The question should be, “Which explanation for the energy efficiency gap in transportation is most likely?” Researchers need to decompose the energy efficiency gap into its various components so that policymakers can identify the most appropriate approaches. More work on producer-side explanations of the energy efficiency gap in the automobile industry is crucial, because no empirical studies exist thus far.