How do Consumers Respond to Gasoline Price Shocks? Heterogeneity in Vehicle Purchase and Driving Behavior

• Environmental and Resource Economics Workshop

Date and Location

Monday, November 15, 2010, 2:10 PM - 3:30 PM

Abstract

With the striking run-up of gasoline prices in 2007 and 2008, sales of SUVs and pickups declined sharply and reports of changes in driving habits filled the news. This paper develops a structural econometric model of vehicle purchase and subsequent driving decisions to examine the consumer responsiveness to gasoline price changes on both the extensive and intensive margins. Both decisions are modeled in a dynamic setting that explicitly accounts for selection on unobserved driving preference. The model leverages a unique and extremely rich dataset of all vehicle registrations in California in 2001-2009, which are matched at the vehicle-level with smog check data that include odometer readings at the time of the test. Results suggest that consumers are responsive to gasoline prices in both vehicle choice and driving decisions, with a medium-run elasticity of fuel economy and driving around 0.09 and -0.13 respectively. These responses vary by income, geographic, and demographic groups. A counterfactual analysis of a gasoline tax that raises the gasoline price by $1 per gallon and a revenue-neutral feebate policy on new vehicles suggest that both policies lead to only a small net welfare loss to consumers, but that a gasoline tax is a much more cost-effective policy. The results provide important insights into the long and short-run determinants of the gasoline price elasticity. They also have key implications for the effectiveness and consequences of policies to reduce emissions from the transportation sector.