FTC Staff Comment Before the National Highway Traffic Safety Administration Concerning Passenger Automobile Average Fuel Economy Standards

, -
~ .,..
VtH1UU~ts
BEFORE fHE
NATIONAL HIGHWA Y TRAFFIC SAFETY ADMINISTRATION
Washington, D.C.
COMMISSION AUTHORIZED
. Passenger Automobile Average
Fuel Economy Standards for
Model Years ]989 and ]990
)
)
)
)
)
)
-------------)
49 CFR Part 531
[Docket No. FE-88-0 1;
Notice 2]
COMMENTS OF THE STAFF OF THE BUREAU OF ECONOMICS
OF THE FEDERAL TRADE COMMISSION-
Washington, D.C. 	20580
September ]5, 1988
• 	These 	comments 	are 	the 	views 	of 	the 	staff 	of 	the 	Bureau 	of
Economics of the Federal Trade Commission. 	They are not necessarily the
views of the Commission or of any individual Commissioner.

',.
I. IntroductioD and Summary
On August 29, J988, the National Highway Traffic Safety Administration
(NHTSA) 	issued 	a 	Notice 	of 	Proposed 	Rulemaking 	(NPRM) 	in 	which 	it
proposed 	that 	the 	Corporate 	Average 	Fuel 	Economy 	(CAFE) standards 	for
model years (MY) 1989 and J990 be reduced from the planned 27.5 miles per
lallon (MPG) to some value in the 26.5 to 27.5 MPG range. l 	In the NPRM,
NHTSA 	has 	asked 	for 	public 	comment 	on 	the 	following 	Questions: 	"[t]o
what 	extent, 	if 	any, 	would 	fuel 	economy 	improvements 	adversely 	affect
.consumer choice of vehicles or engines?";2 and "[t]o what extent, if any, are
U.S. jobs affected by the level of the MY 1989-90 CAFE standards and thus
at issue 	in 	this rulemaking?"3 	In 	response 	to these Questions, the staff of
the 	Bureau 	of 	Economics 	of 	the 	Federal 	Trade 	Commission 	("the 	staff")
submits 	the 	following 	analysis 	of 	the 	consequences 	of a 	27.5 	MPG 	CAFE
standard 	for 	consumer 	welfare, 	automobile 	industry 	profits,· 	automobile
worker employment, and energy consumption. 5 ,6
Our analysis indicates that adopting a 27.5 MPG standard instead of a
1 53 	Federal 	Register 	33,081, 	August 	29, 	1988 	(hereafter 	cited 	as
"NPRM"). 	NHTSA has set a deadline of September 15 for comments on MY
J989, and a deadline of October 28 for comments on MY 1990 standards. 	We
ask that these comments be considered in the latter rulemaking as well.
2 Question 13, 53 Fed Reg. at 33,092.
3 Question 15, 53 Fed. Reg. at 33,093.
• NHTSA 	has 	observed 	that 	compelling 	firms 	to 	comply 	with 	CAFE
standards through the elimination of car models with low MPG performance
could 	re~ ~It in substantial reductions in sales for 	individual 	manufacturers.
NHTSA 	observed 	further 	that 	these 	sales 	losses 	"could 	have 	an 	adverse
economic impact on the industry and the economy as a whole, and could run
counter 	to 	the 	statutory 	criterion 	of 	economic 	practicability 	and 	the
Congressional 	intent 	that 	the 	CAFE program 	not 	unduly 	restrict 	consumer
choice." 	53 Fed Reg. at 33,092.
5 In 	considering 	regulatory 	adjustments 	to 	the 	statutorily 	established
CAFE standards, NHTSA is required inLer alia to take account of "the need
of the Nation to conserve energy." 	53 Fed. Reg. at 33,081.
6 These 	comments 	are 	the 	views 	of 	the 	staff 	of 	the 	Bureau 	of
Economics of the Federal Trade Commission. 	They are not necessarily the
views 	of 	the 	Commission 	or 	of 	any 	individual 	Commissioner. 	Inquiries
regarding these comments should 	be directed 	to staff economist 	Andrew N.
Kleit, 	Bureau 	of 	Economics, 	Federal 	Trade 	Commission, 	Washington, 	D.C.,
20580, (202)-326-3481.

26.6 MPG standard 7 would result in a significant number of consumers paying
more than they otherwise would for new large cars with lower fuel economy.
Despite increases in 	the 	production 	of new small cars, employment 	in 	the
domestic auto and auto-related industries would likely also be reduced by the
higher CAFE standard. 	Small car production requires less labor per vehicle
than 	large car production, so the reduced sales of larger cars causes a net
reduction in total employment. 	The NHTSA is required by law to compare
these 	costs 	against 	the 	benefits 	of 	the 	CAFE 	program. 	Our 	evaluation,
however, 	fails 	to 	find 	any 	benefits 	to 	higher 	CAFE 	standards. 	In
particular, our results indicate that imposition of higher CAFE standards may
.actually 	lead 	to increased 	net 	gasoline consumption 	in 	the 	years 	following
the imposition of the standard.
We 	evaluate 	the 	impact 	of 	a 	higher 	CAFE 	standard 	under 	two
alternative 	scenarios. 	Scenario 	I 	assumes 	that 	the 	27.5 	MPG 	standard 	is
first 	imposed 	in 	MY 	1989, 	while 	Scenario 	2 	assumes 	that 	the 	27.5 	MPG
standard 	is first 	imposed 	in 	MY 	1990. 8 	We 	estimate 	that 	imposing a 	27.5
MPG 	standard 	instead 	of 	a 	26.6 	MPG 	standard 	in 	MY 	1989 	would 	cost
consumers 	almost 	$650 	million 	(because 	of 	increased 	prices 	for 	large 	cars
with low MPG ratings) in MY 	1989. 	Domestic auto industry profits would
fall 	by about 51.553 billion that same year. 	Total employment in domestic
auto and 	auto-related 	industries would 	likely decline by about 	11,500 jobs.
Meanwhile, 	we estimate 	that 	the 	higher standard 	would, by decreasing 	the
retirement rate for existing large cars and increasing the rates of production
and utilization of new small cars, actually increase gasoline consumption by a
total of approximately 245 million gallons over the 15 year period following
the imposition of the standard. 	For the most part, the changes in gasoline
consumption 	identified 	here do not occur in 	the model years to which the
CAFE 	standard 	would 	be 	applied. 	Rather, 	they 	are 	the 	summation 	of
gasoline consumption changes for the ensuing 15 years. 9
Similar results Rre obtained under scenario 2, which assumes 	that the
27.5 MPG 	standard 	:IS first imposed 	in MY 	1990. 	Enforcement of the 27.5
MPG 	standard 	instead 	of 	the 	lower 	standard 	would 	cost 	consumers
approximately 5950 million, and reduce auto companies' profits by about 5700
million, in MY 1990. 	Employment in auto and auto-related industries would
decline 	by 	about 	20,000 	jobs, and 	gasoline 	consumption 	would 	increase 	by
about 200 million gallons between 1990 and 2005.
7 Our 	analysis 	assumes 	that 	any 	CAFE 	standard 	below 	26.6 	MPG 	is
nonbinding for all manufacturers. 	Any standard below 26.6 MPG (e.g., 26.5
MPG) could therefore be expected to have the same effects as a 26.6 MPG standard.
8 The 	changes 	in 	consumer 	and 	producer 	welfare, 	employment, 	and
gasoline 	consumption 	that 	are 	generated 	under 	the 	second 	scenario 	thus
should 	not 	be 	interpreted as incremental changes (relative to those changes
arising 	under 	stenario 	1); 	rather, 	they 	should 	be 	regarded 	as 	alternative
estimates that correspond to a different assumption about the timing of the
regulatory change.
9 These future consumption changes are discounted at a rate of 4 percent.
2

These 	results 	are 	based 	on 	the 	assumption 	that 	GM 	is 	unable 	to
overturn 	recent court decisions and 	gain 	additional 	CAFE credits. 	Should
GM 	win 	its 	court 	chaJlenge, 	we 	estimate 	that 	imposing 	the 	higher 	CAFE
standard 	will result in 	lesser, though still significant harm to the economy.
Imposing a 27.5 MPG CAFE standard rather than a lower standard would,
under these circumstances, also lead to increased gasoline consumption during
the ensuing ] 5 year period.
OveraJl, 	our 	analysis 	suggests 	that 	enforcement 	of 	higher 	CAFE
. standards 	would 	yield 	few 	social 	benefits, 	and 	that 	it 	would 	impose
substantial costs on the U.S. economy. 	We therefore recommend that NHTSA
adopt a standard no greater than 26.6 MPG for MYs 1989 and 1990.
II. Federal Trade Commission Experience
The FTC is an independent regulatory agency responsible for fostering
competition and safeguarding the interests of consumers. 10 	The staff of the
FTC, upon request by federal, state, and local government bodies, regularly
analyze 	regulatory 	proposals 	to 	identify 	provisions 	that 	may 	impair
competition 	or 	increase 	costs 	without 	offering 	compensatory 	benefits 	to
consumers. 	The 	FTC 	also 	has 	a 	statutory 	responsibility 	to 	review
complaints that the CAFE standards harm competition. ll
In 	1986 	the 	FTC 	staff 	submitted 	comments 	when 	NHTSA 	was
considering modifying CAFE standards for model years 1987 and 1988. 12 	Our
comments were cited as an important justification for 	NHTSA's decision 	in
10 15 U.S.c. Section 41 et seq.
11 The Secretary of the Department of Transportation 	may modify or
waive CAFE civil penalties under certain limited circumstances, one of which
is certification by the FTC that modificat-ion is necessary to prevent harm to
competition. 	IS 	U.S.c. 	§ 	2008 	(b)(3)(C). 	The 	statute 	provides 	that 	a
manufacturer may petition the FTC for a certification that modification of
the 	civil 	penalty 	"is 	necessary 	to 	prevent 	a 	substantial 	lessening 	of
competition 	in 	that 	segment 	of 	the 	automobile 	industry 	subject 	to 	the
standard 	with respect to which such penalty was assessed." 	15 U.S.C 	§ 2008
(b)(4).
12 	Comments of the Bureaus of Competition, Consumer Protection, and
Economics 	of 	the 	Federal 	Trade Commission, 	Passenger 	Automobile A\'erage
Fuel 	Economy 	Standards 	Model 	Year 	1987-88, 	National 	Highway 	Traffic
Safety 	Administration, 	Docket 	No. 	FE·8S-0I, 	March 	26, 	1986 	(hereinafter
cited as FTC Staff (1986».
3

that rulemaking. 13 	In addition, members of the FTC staff have conducted a
series of empir\cal~studies of the effects of the CAFE law. H
III. Description of the CAFE Proeram
The 	CAFE 	program, 	as 	enacted 	in 	1975, 	called 	for 	all 	auto
manufacturers' producing 	more 	than 	10,000 	units 	per 	year 	to 	satisfy 	the
mandated CAFE levels. 	The CAFE program defines average MPG standards
that apply to a manufacturer's entire fleet, rather than to the fuel efficiency
of individual models. 	CAFE levels were scheduled to rise from 18.0 MPG in
·1978 to 27.5 MPG in 	1985 and all subsequent years. 	Failure to satisfy the
standard can result in the imposition of civil penalties. 1S
The CAFE legislation divided each manufacturer's fleet into two distinct
groups 	-- 	foreign 	and 	domestic. 	All 	domestic 	cars 	and 	all 	foreign 	cars 16
sold 	by 	each 	firm 	were 	to 	be 	averaged 	separately.17 	This 	provision 	was
designed 	explicitly 	to 	prevent 	U.S. manufacturers 	from 	meeting 	the 	CAFE
standard 	by 	importing 	small, 	high 	MPG 	foreign 	cars. 	Instead, 	domestic
firms are induced to produce high MPG cars in the U.S. 18
Although 	the 	CAFE 	standards 	are 	defined 	by 	statute,IQ 	NHTSA 	is
empowered (through regulatory rulemakings) to adjust the CAFE standard for
model year 1985 and any subsequent year to the "maximum feasible average
fuel economy level." 	In determining this maximum feasible level, NHTSA is
required to consider four factors: 	(I) technological feasibility, (2) economic
practicability, (3) the effect of other federal motor vehicle standards on fuel
economy, and (4) the need of the nation to conserve energy.20
13 51 Federal Register 35,598, October 6, 1986.
H 	See 	Andrew 	Kleit, 	"The 	Economics 	of 	Automobile 	Fuel 	Economy
Standards," Ph.D. dissertation, Yale Universit" 	1986. 	Also see Andrew Kleit,
"The Impact of Auto Fuel Standards," FTC Working Paper No. 160, February
1988, 	and 	"Enforcing 	Time 	Inconsistent 	Government 	Regulations," 	FTC
Working 	Paper 	No. 	161, 	March 	1988; 	Robert 	P. 	Rogers, 	"The 	Short-Run
Impact 	of 	Changes 	in 	the 	Corporate 	Average 	Fuel 	Economy 	Standards,"
manuscript, March 1986.
15 So far, 	however, 	no domestic manufacturers, and only a 	few small
European firms,~ave actually paid fines.
16 A foreign 	car is defined as one having 	less than 	75% of 	its value
added produced in the United States.
17 NPRM, p. 33,080.
18 NHTSA Annual Report on Fuel Economy, 1982, p. 9.
19 Title 	V 	of 	the 	Motor 	Vehicle 	Information 	and 	Cost 	Savings 	Act
(hereafter "the Act"), 15 U.S.c. 2001 el seq.
20 NPRM, p. 33,081.
4
....

IV. CAFE Staadards aad Curreot U.S. Eaern Policy
When 	first 	promulgated 	in 	1975,21 	the CAFE 	program 	was 	part 	of 	a
complex 	scheme of 	regulation 	designed 	to 	reduce 	consumption 	of 	gasoline
directly. 	These 	controls 	on 	consumption 	were 	promulgated 	because
policymakers believed that increases in the price of energy would not reduce
gasoline consumption to levels consistent with national security interests.
Events 	subsequent 	to 	the 	enactment 	of 	the 	CAFE 	law 	suggest 	that
.consumers 	do 	respond 	to 	market 	forces. 22 	However, 	there 	is 	debate 	over
whether 	market-determined 	prices 	fully 	reflect 	all 	of 	the 	costs 	gasoline
consumption imposes on society. 	It is possible that consumption of gasoline
creates 	external 	social 	costs, 	or 	"externalities", 	which 	are 	costs 	associated
with 	consumption 	and 	production 	decisions 	that 	are 	ignored 	by 	private
decisionmakers. 	If 	true, 	the 	volume 	of 	gasoline 	produced 	and 	consumed
would 	differ 	from 	what 	it 	would 	be 	if 	all 	costs 	were 	fully 	taken 	into
account. 	For example, the original goal of the CAFE program was to ensure
political and social stability by reducing dependence on imported petroleum
supplies. 	Social 	instability 	caused 	by 	oil 	embargoes 	and 	other 	supply
disruptions 	has been 	characterized 	by some as 	an 	externality.23 	Similarly,
the 	burning 	of 	gasoline 	has 	been 	linked 	to 	both short-term 	and 	long-term
environmental degradation.
Federal and state legislative bodies have available to them methods for
internalizing 	external 	costs 	that 	are 	more 	efficient 	than 	performance
standards. 	If 	gasoline 	consumption 	is 	the 	source 	of 	an 	externality, 	an
efficient alternative to a CAFE standard is the imposition of an excise tax
21 15 U.S.c. § 1901,2001·2012.
22 Studies 	have 	found 	that 	consumers 	in 	fact 	purchase 	more 	fuel-
efficient 	cars 	when 	gasoline 	prices increase. 	In 	Europe and 	Japan, where
gasoline prices are much higher than 	those in the United States, consumers
purchase cars offering much higher gas miJeage. 	Indeed, empirical research
indicates that American consumers have responded to higher gasoline prices
by 	buying 	more 	fuel-efficient 	vehicles. 	According 	to 	one 	study, 	rising
gasoline prices caused the change in average new car mileage between 	1970
and 	1983 to be the same as it would have been had the CAFE program not
existed. 	See 	Robert 	Crandall, "Why Should 	We 	Regulate 	Fuel 	Economy 	at
All," 	Brookings 	Review 	(Spring 	1985), 	p. 	4 (hereafter 	Crandall 	(1985», 	and
Robert F. Crandall, Howard K. Gruenspecht, Theodore E. Keeler, and Lester
B. Lave, Regulating the Automobile. 	Washington: 	The Brookings Institution,
1986, p. 134-5.
23 See, for 	example, Harry 	Broadman and 	William 	Hogan, "Oil Tariff
Policy 	in 	an 	Uncertain 	Market," 	Discussion 	Paper 	E-86-11, 	Energy 	and
Environmental 	Policy 	Center, 	John 	F. 	Kennedy 	School 	of 	Government,
Harvard University, November 1986.
5

on 	gasoline 	consumption. 2• 	A 	large 	body 	of 	research 	that 	measures
consumer responses to variations in gasoline prices shows generally that the
quantity of gasoline demanded falls when prices rise. 26 	If Congress, or any
of the individual states, wishes to discourage gasoline consumption because it
creates 	externalities, 	the 	most 	direct 	and 	reliable 	technique 	for 	doing 	so
would 	be 	to 	raise 	the 	price 	of 	gasoline 	through 	higher 	taxes. 	Setting
performance standards such as CAFE, by contrast, is an indirect, imprecise
method for reducing gasoline consumption, and one that may (as our model
simulations 	suggest) 	actually 	increase 	total 	gasoline 	consumption 	and 	total
external costs.
v. Economic Analysis of the Imposition of CAFE Standards
Model 	Year 1989 will begin at about the time NHTSA determines the
MY 1989 CAFE standard. 	Although the auto companies have been aware of
the potential for a 27.5 MPG standard for some time, GM and Ford now have
little 	time 	left 	to 	increase 	the 	fuel 	efficiencies 	of 	individual 	automobile
models. 	Technological 	changes of this sort generally 	take several 	years 	to
accomplish. 	Indeed, 	NHTSA 	recognizes 	that 	significant 	technological
changes 	cannot 	be 	made 	at 	this 	late 	date 	even 	for 	MY 	1990.26 	Thus, 	if
NHTSA 	refuses 	to 	lower 	the 	CAFE 	standard, 	these 	firms 	may 	have 	to
"mix-shift" to satisfy a CAFE standard of 27.5 MPG. 	"Mix-shifting" means
that these manufacturers will 	raise the price, and 	reduce the quantity sold
(relative 	to the 	prices and 	quantities otherwise dictated 	by 	market 	forces),
of cars having low MPG ratings, and reduce the price, and raise the quantity
sold, of cars offering high MPG ratings.
Given that the CAFE standard will force automakers to raise the price
of larger 	cars relative 	to the price of small cars, it establishes an 	internal
2. While 	we 	believe 	that 	excise 	taxes 	are 	preferred 	to 	performance
standards 	as 	a 	means 	for 	eliminating 	externalities 	when 	these 	externalities
have been shown to exist, this should not be construed as an endorsement of
any specific proposal to increase existing excise taxes on gasoline. 	We have
not 	attempted 	to 	measure 	the 	externalities 	that 	might 	be 	generated 	by
current gasoline consumption levels, and 	therefore are 	not 	in a 	position 	to
evaluate the benefits and costs of altering these consumption levels.
25 The long-term price elasticity of gasoline demand has been estimated
to be 	between -0.6 and -1.1. 	Elasticity of demand is the percentage change
in quantity demanded divided by the percentage change in price. 	Thus, if
the elasticity of demand 	is -0.6 and 	the price of gasoline rises 	10 percent,
the 	demand 	for 	gasoline 	will 	fall 	6 	percent. 	For 	a 	discussion 	of 	the
literature measuring the response of consumer to changes in gasoline prices,
see Carol A. Dahl, "Gasoline Demand Survey," Energy Journal. January 1986.
26 NPRM, p. 33,092.
6

system 	of quasi-taxes 	and 	subsidies 	for 	the 	autos 	of 	each 	manufacturer. 27
The 	change in 	price 	of each 	type 	of car depends 	on 	the 	relation 	of 	that
car's 	fuel 	efficiency 	to 	the 	CAFE 	standard 	-- 	i.e., 	the 	lower 	the 	fuel
efficiency of a 	particular 	model, the grea ter 	the 	increase in 	price -- 	the
cost to any particular firm of meeting the standard, and various other supply
and demand conditions.
It 	is 	clear 	that 	purchasers 	of 	new 	large 	cars 	are 	harmed 	by
mix-shifting 	and 	that 	purchasers 	of 	new 	small 	cars 	benefit. 	Overall,
however, 	new 	car 	purchasers 	are 	likely 	to 	incur 	a 	net 	loss 	from 	the
.imposition of CAFE standards because many more large cars than small cars
are demanded 	at the 	prices prevailing 	before 	the 	imposition 	of the 	higher
standard.28
It 	is 	not 	clear 	whether 	CAFE 	regulations 	will 	achieve 	their 	goal 	of
reducing 	the 	total 	amount 	of 	domestically 	consumed 	gasoline. 	Total
domestic 	gasoline 	consumption 	is 	determined 	by 	three 	factors: 	(l) 	the
average 	number 	of 	gallons 	of 	gasoline 	required 	to 	drive 	a 	mile, 	(2) 	the
average 	number 	of 	miles driven 	per 	vehicle, 	and 	(3) 	the 	total 	number 	of
vehicles owned by American consumers. 	By establishing standards for newly
produced 	cars, 	CAFE 	regulations 	directly 	address 	only 	the 	first 	of 	these
factors. 	If 	the 	latter 	two 	factors 	do 	not 	change 	subsequent 	to 	the
imposition 	of 	the 	regulations, 	and 	if 	the 	rate 	of 	replacement 	of 	existing
large 	cars 	is 	not 	reduced 	in 	response 	to 	the 	standards, 	then 	the 	program
will fulfill 	its Objective of reducing total fuel consumption. 	It is unlikely,
however, 	that 	these 	factors 	would 	remain 	constant; 	rather, 	it 	is 	quite
plausible 	that 	CAFE 	standards 	could 	cause 	both 	of 	the 	latter 	factors 	to
change in ways that would partly, and perhaps totally, offset any reduction
in 	total 	gasoline 	consumption 	brought 	about 	by 	greater 	per-vehicle 	fuel
efficiency.
For example, one effect of imposing a higher CAFE standard would be
to 	increase 	the 	number 	of 	miles 	driven 	in 	newly 	produced 	cars. 	This 	is
because lower rates of fuel consumption per mile will induce an increase in
27 By artificially decreasing large car production, and increasing small
car production, imposing a higher CAFE standard is conceptually similar to
placing a tax on 	large cars, and a subsidy on small cars. 	Because of these
taxes and subsidies, automobile prices would no longer accurately reflect true
resource 	costs. 	As 	a 	consequence, 	consumers' 	choices 	would 	become
distorted, which in turn generates deadweight welfare losses to the economy.
See 	John 	E. 	K woka 	Jr., 	-The 	Limits 	of 	Market 	Oriented 	Regulatory
Techniques: 	The 	Case 	of 	Automotive 	Fuel 	Economy 	Standards; 	Quarterly
Journal of Economics (1983), 695-704, and Kleit (1987) and (1988).
28 Absent 	externalities, 	competitive 	market 	forces 	will 	produce 	the
quantities of large and small cars that maximize social 	welfare. 	Since the
CAFE standards cause a movement away from these quantities (i.e., too few
large 	automobiles, 	too many 	small automobiles), 	the 	standards .reduce 	total
social welfare.
7

the 	total 	number 	of 	miles 	driven. 29 	This 	increase 	in 	total 	mileage 	will
offset, to some extent, the reduction in fuel consumption brought about by
the higher fuel consumption standard.
Additionally. the total number vehicles owned by American consumers
may 	increase 	because of the 	imposition 	of CAFE standards. 	As discussed
above. the CAFE regulation may cause the price of new small cars to fall,
and 	price 	of 	new 	large 	cars 	to 	rise, 	relative 	to 	market-determined 	prices.
Depending 	on 	the 	comparative 	magnitudes 	of 	these 	price 	changes, 	the
increase in the number of small cars produced could 	more than offset the
.decline in large car production. so 	Although this lower price for new small
cars 	will 	induce 	some 	of 	the 	owners 	of 	old, 	large 	cars 	to 	replace 	their
vehicles 	with 	new small 	cars, the 	increase 	in 	the 	price 	of new 	large 	cars
will induce other large car owners to hold on to these vehicles longer than
they 	would have otherwise. 31 	The price increase for new large cars would
also 	induce 	increased 	production 	of 	large· cars 	by 	producers 	currently
unconstrained by the CAFE standard.32
VI. Simulating the Effects of CAFE Standards
This section 	will 	estimate the effects 	of 	various 	CAFE 	levels on 	the
automobile market and on energy consumption. 	Part A analyzes the effects
of 	CAFE 	on 	consumer 	welfare, 	auto 	industry 	profits, 	and 	auto 	industry
employment. 	This appraisal will take account of savings that result from the
introduction 	of 	new 	cars 	whose 	prices and 	quantities 	are 	affected 	by 	the
CAFE standard, as well as any changes in the stock of used automobiles that
are attributable to the changes in 	the price of new cars. 	Part B examines
the 	change 	in 	energy 	consumption 	that 	will 	occur 	if 	the 	higher 	CAFE
standard is enforced.
29 See Roger D. Blair, David L. Kaserman, and Richard C. Tepel, "The
Impact 	of 	Improved 	Gasoline 	Mileage on 	Gasoline 	Consumption," Economic
Inquiry (1984),209·217.
30 See K woka, p. 702.
31 This 	phenomenon 	has 	been 	observed 	in 	other 	regulatory 	contexts.
For example, it has been argued that increasing the stringency of pollution
controls 	could 	actually 	increase 	pollution 	by 	deterring 	the 	replacement 	of
older, 	more 	pollution-intensive 	automobiles. 	See 	Howard 	K. 	Gruenspecht,
"Differentiated 	Regulation: 	A 	Theory 	with 	Applications 	to 	Automobile
Emission 	Controls: 	Yale 	University 	Ph.D. 	dissertation, 	1982a, 	and
Gruenspecht. 	"Differential 	Regulation: 	The 	Case 	of 	Auto 	Emissions
Standards: American Economic Review (J982b), 328·331.
32 Chrysler: 	for 	example, 	is 	not 	currently 	constrained 	by 	the 	CAFE
standard. 	If 	prices 	for 	large 	new 	cars 	(e.g., 	Cadillacs, 	Lincolns) 	were 	to
rise, 	Chrysler 	could 	profitably 	increase 	its 	production 	of 	its 	large 	models
(e.g., 	the 	New 	Yorker) 	without 	jeopardizing 	its 	compliance 	with 	the
standard.
8

Our 	model 	is 	an 	approximation 	of 	the 	markets 	for 	automobiles 	and
gasoline. 	It 	is 	based, 	however, 	on 	a 	set 	of 	reasonable 	assumptions 	that
reflect the most recent research into the auto industry. 	As with all models,
its predictions contain an element of uncertainty. 	Nevertheless, we believe
that 	this 	model 	generates 	useful 	insights 	into 	the 	likely 	impact of 	higher
CAFE standard!'.
A. Automobile Market Model
To 	Quantify 	the 	costs 	to 	consumers, 	and 	to 	the 	auto 	industry, 	of
imposing a 27.5 MPG CAFE standard, rather than a 26.6 MPG standard, for
MYs 	1989 	and 	1990, 	we 	have 	constructed 	a 	model 	that 	estimates 	the
production shifts, price changes, and employment effects that 	would 	result
from 	the standard. 	This model is an extension of the model used by Kleit
(1987, 	1988) and is very similar to the simulation used by FTC staff in its
1986 submission to NHTSA. 	A description of this model is contained in the
technical appendix attached to these comments.
Table 	A-I 	of 	the 	technical 	appendix 	contains 	the 	simulation 	results
obtained 	from 	the 	automobile 	market 	model 	corresponding 	to a 	27.5 	MPG
CAFE 	standard 	for 	Model 	Year 	1989. 	The 	model 	predicts 	a 	net 	loss 	to
consumers of S644 million in MY 1989. 	General Motors' profits in that year
fall 	by 	S463 	million, 	while 	Ford's 	profits 	decrease 	by 	SI.209 	billion.
Chrysler's 	(which 	is 	currently 	unconstrained 	by 	CAFE 	regulation) 	profits
increase by S139 million. 	The net loss to the domestic economy (the sum of
consumer 	and 	producer 	losses) 	is 	approximately 	S2.177 	billion. 	Overall
employment in the auto and auto-related industries falls by 11,500 jobs.
Table A-2 gives the projected impact of a 27.5 MPG CAFE standard for
MY 	1990. 	The net loss to consumers in that year is S95S million. 	General
Motors' MY 	1990 profits are 	reduced by $208 	million, while Ford's profits
fall by S704 million. 	Chrysler's profits rise by $223 million. 	The net loss to
the domestic economy is approximately $1.644 billion. 	Overall employment in
the auto and auto-related industries falls by almost 20,000 jobs.
Should 	GM 	successfully 	pursue 	its 	current 	court 	challenge 	and 	gain
additional 	CAFE 	mileage 	credits, 	the 	net 	harm 	to 	the 	economy 	would 	be
smaller than predicted above. 	Tables A-4 and A-S contain our estimates of
the economic impact of CAFE under this alternative scenario. 	In model year
1989, 	imposing 	the 	27.5 	MPG 	instead 	of 	a 	26.6 	MPG 	standard 	increases
consumer 	welfare 	by $336 million, decreases U.S. manufacturers' profits by
$1.624 billion, and increases employment in auto and auto-related industries
by 7,490 jobs. 	In model year 1990, the 27.5 MPG standard reduces consumer
welfare by $234 million, decreases auto profits by $856 million, and reduces
employment 	by about 6,600 	jobs. 	In 	both 	years, Ford 	is obliged 	to 	make
more 	product 	changes 	than 	GM 	to 	satisfy 	the 	standard." 	Under 	either
scenario, consumers are worse off in MY 1990 than in MY 1989 because GM
S! Thus, Ford's losses are proportionately (and absolutely) greater than
GM's.
9

-.. ...
must 	make a 	l~rg~r product change in that year. 	However, losses for GM
and Ford are lower in MY 	1990 because the model assumes that, given one
year's lead time, GM and Ford will be able to produce more high MPG cars
in an attempt to comply with a 27.5 MPG CAFE standard.
B. Gasoline CODsumptioD Model
To measure the change in gasoline consumption 	that 	will result from
changing 	the 	CAFE 	standard, 	it 	is 	necessary 	to 	estimate and 	compare 	(l)
·the lifetime gasoline consumption of new cars sold 	under the standard, (2)
the 	estimated 	gasoline 	consumption 	of 	the 	cars 	that 	would 	have 	been
produced 	had 	the 	higher 	CAFE 	standard 	not 	been 	imposed, 	and 	(3) 	the
"scrappage effect" (the change in the stock of used cars that results from a
change 	in 	the 	price 	of 	new 	cars) 	to 	determine 	the 	total 	stock 	of cars 	in
operation.M 	Many 	of 	the 	changes 	in 	fleet 	composition 	reflect 	large 	car
buyers switching 	to 	new 	small cars 	in 	response 	to changes 	in 	relative 	car
prices. 	But because smaller cars use less fuel, the marginal cost of driving
declines, and driving is encouraged. 	The model uses Blair et al.'s3s findings
to 	adjust 	for 	changes 	in 	the 	rate 	of 	use 	of 	new 	cars 	induced 	by 	higher
CAFE standards.
Data 	on 	miles 	driven 	and 	scrappage 	rates 	are 	incorporated 	into 	the
gasoline 	consumption 	calculations. 36 	The 	scrappage 	rates 	are 	adjusted 	for
new 	car 	price 	changes 	using 	Gruenspecht's 	estimates.37 	Gruenspecht
showed 	that 	if 	the 	price 	of 	new 	cars 	is 	raised 	(lowered), 	it 	causes 	a
significant decrease (increase) in the scrappage rates of used cars. 	Here we
assume that Gruenspecht's results can be applied to each of the three classes
of automobiles (Basic Small, Luxury Small, and Large). 	For purposes of the
gasoline 	consumption 	model, 	Japanese 	cars 	are 	combined 	with 	their
corresponding American segments. 38
34 Several studies, such as Gruenspecht (1982a and 	1982b), have found
that 	scrappage 	rates 	of 	used 	cars 	are 	significantly 	affected 	by 	new 	car
prices. 	See 	also James 	A. 	Berkovic, "New Car Sales and 	Old 	Car Stocks,"
RAND 	Journal 	of 	Economics 	(1985), 	195-214 	and 	Richard 	W. 	Parks,
"Determinants 	of 	Scrappage 	Rates 	for 	Postwar 	Vintage 	Automobiles,"
Econometrica (1977) 1099-1115.
3S Blair, Kaserman, and Tepel (1984).
36 Figures obtained 	from 	the Motor Vehicle Manufacturer Association,
Motor Vehicle Facts and Figures (1987).
37 Gruenspecht (1982b).
38 The 	MPG 	values 	for 	each 	of 	the 	three 	classes 	can 	be 	determined
from the information used in the automobile market model. 	The entire fleet
fuel efficiency for 1973 is known to be about 14.2 MPG. 	The model assumes
that the ratio of fuel efficiencies between classes is the same for each year.
10
....

The 	simulation 	was 	performed 	for 	both 	the 	1989 and 	1990 scenarios
with 	the additional scrappage and substitution effects (described above) for
various CAFE levels. 	As we noted earlier in § V of these comments, CAFE
standards could, paradoxically, increase gasoline consumption because of the
interplay 	of 	four 	factors: 	a 	reduced 	retirement 	rate 	of 	existing 	fuel-
inefficient large cars, an increased rate of production, and rate of use, of
new small cars, and an increased production rate of new large cars by firms
currently unconstrained by the CAFE standards.
For the most part, the changes in gasoline consumption identified here
do 	ndt 	occur 	in 	the 	model 	years 	to 	which 	the 	CAFE 	standard 	would 	be
applied. 	Rather, they 	are the summation of gasoline consumption 	changes
for the ensuing 15 years. 	A real discount rate of 4 percent is used.
Our results are consistent with this possibility. 	The consumption model
predicts 	that 	gasoline 	use 	would 	actually 	increase 	if 	the 	higher 	CAFE
standard 	were enforced. 	The model 	predicts that 	establishing a 	27.5 MPG
standard instead of a 26.6 MPG standard in model year 1989 would increase
gasoline consumption 	by approximately 245 million gallons over the ensuing
15 year period. 	Imposing a 27.5 MPG standard for MY 	1990 raises gasoline
consumption by approximately 200 million gallons. 	When the simulation 	is
performed 	under the "alternative scenario" (i.e., if GM obtains its additional
mileage credits), gasoline consumption over the 15 year period following the
imposition of the standard increases by 341 	million gallons and 288 million
gallons, respectively, for MYs 1989 and 	1990.!9 	Thus, rather than achieving
its 	intended 	effect 	of 	reducing 	consumption 	of 	gasoline, 	raising 	CAFE
standards appears likely to accomplish the exact opposite.
With 	this 	assumption, 	knowledge of 	the 	fraction 	of 	cars in 	each 	class 	for
1973, and 	the entire fleet fuel efficiency for 	1973, the fuel 	efficiency for
each class of new car in 	1973 can 	be estimated. 	We also assume that, for
each class of car, fuel efficiency grew at a constant rate between 1973 and
1987. 	MPG's are then calculated accordingly. 	The 	fuel 	efficiency of cars
produced before 1973 is assumed equal to be to the 1973 level.
!9 Changes in gasoline consumption do not vary directly with changes
in 	the 	CAFE 	standard. 	That 	is, 	increasing 	the 	standard 	may 	increase
gasoline consumption when the change in the standard does not exceed some
threshold 	level; increases 	in 	the standard 	beyond 	that 	threshold 	will 	cause
total 	consumption 	to 	decrease. 	Gasoline 	consumption 	appears 	to 	increase
when the CAFE standard is increased by less than 1.0 MPG, and decrease for
larger 	CAFE 	level 	increases 	(Kleit 	(1987), 	p. 	99). 	Decreasing 	gasoline
consumption 	through 	higher 	CAFE standards appears 	to 	be 	very 	costly 	to
society. 	Kleit (1988) estimates this cost to be in the range of $4.00 - 55.00
per gallon.
I I

VII. Conclusion
Our comparison of a 27.5 MPG CAFE standard to a 26.6 MPG standard
suggests 	that the higher standard 	will harm consumers and auto producers,
reduce 	employment 	in 	the 	auto 	industry. 	and 	increase 	total 	fuel
consumption. 	This 	analysis 	assumes 	that 	GM 	will 	be 	unable 	to overturn
recent court decisions and gain additional CAFE credits. 	Should GM win its
court challenge. we estimate 	that 	imposing the 	higher CAFE standard 	will
result 	in 	lesser. 	though 	still 	significant. 	harm 	to 	the 	economy. as 	well 	as
increased gasoline consumption. 	We therefore recommend that NHTSA adopt
. a CAFE standard no greater than 26.6 MPG for MYs ]989 and ]990.
12

Technical Appendix·
Andrew N. Kleit
• 	This 	appendix 	has 	been 	prepared 	by 	a 	staff 	member 	of 	the 	Bureau 	of
Econor.'cs of the Federal Trade Commission. 	It has not been reviewed by.
nor does it necessarily reflect the views of, the Commission or its members.

I. Description of Automobile Market Model
The 	automobile 	market 	model 	presented 	here 	is 	an 	extension 	of 	the
model used by Kleit (1987, 1988), and is very similar to the simulation used
by the FTC staff in its 1986 submission to NHTSA. 	Model year 1987 serves
as 	the 	base period. 	In 	the 	model 	there are 	five 	types of automobiles: (l)
Asian Basic Small, which includes regular minicompacts and subcompacts such
as the Sentra, the Corolla, and the Hyundai; (2) Asian Luxury Small, which
includes specialty subcompacts and regular compacts such as the RX7 and the
Stanza; 	(3) 	American 	Basic 	Small, 	which 	includes 	minicompacts 	and
. subcompacts such as the Cavalier and the Escort; (4) American Luxury Small,
which 	includes 	specialty 	subcompacts 	and 	regular 	compacts, 	such 	as 	the
Reliant 	K 	and 	the 	Mustang; 	and 	(5) 	American 	Large, 	which 	includes
intermediate 	and 	large 	cars 	such 	as 	the 	Cutlass, 	the 	LTD, 	and 	the 	New
Yorker. 	This breakdown 	is 	based on categories used 	by Ward's 	Automotil'e
Yearbook.} 	Luxury European cars, which 	constitute about 4 percent of the
market, 	are 	excluded 	from 	the 	model. 	Volkswagen 	and 	Yugo 	cars 	are
included in the American Basic small segment. 	On-shore Asian production is
included 	in 	the 	Asian 	segments. 	·Captive" 	imports 	(autos 	built 	by 	Asian
firms 	but 	sold 	under 	American 	nameplates) 	are 	included 	in 	the 	Asian
segments.
During 	the 	1980s, Japanese 	car 	sales 	in 	the 	United 	States 	have 	been
restricted by import quotas ("voluntary restraint agreements"). 	Currently the
quota 	is 	set 	at 	2.3 	million 	units. 	However, 	during 	the 	1987 	model 	year
Japanese 	imports 	were 	only 	about 	2.25 	million 	units. 	Thus, 	the 	initial
implicit tariff is set to O.
Each segment is divided into constrained and unconstrained production.
Constrained 	are 	Japanese 	imports 	(potentially 	by 	the 	import 	quota) 	and
General 	Motors and 	Ford (by 	CAFE standards). 	Unconstrained 	production
includes 	on-shore 	Japanese 	and 	off-shore 	Korean 	output, 	Chrysler,
Volkswagen, and Yugo. 	The quantities, prices, and fuel efficiencies for each
type of car for model year 1987, are shown in Table A-3.
Equilibrium prices and quantities are computed through a series of five
demand and thirteen supply equations. 	Quantity demanded is determined by
a set of linear demand curves'
(1) Q .. AP + B
where Q is the vector of five quantities, P is the price vector, A is a five
by five matrix of slope coefficients, and B is a vector of intercepts.
} Ward's Automotive Yearbook (1988), p. 155 and 233.
, 	With 	the 	imposition 	of 	a 	standard, 	linear 	curves 	generate 	less
deadweight loss than constant elasticity curves.

--"0
•
Quantity silpplied is determined by a set of linear supply curves
(2) Q s C(P-T) + D(P-V) + E + F
where C is a diagonal five by five matrix of supply coefficients for GM and
constrained Japanese firms, D is a diagonal matrix of supply coefficients for
Ford (with 	the first 	two diagonal elements equalling zero), E is a diagonal
five by five matrix of supply coefficients for the unconstrained firms, F is a
vector of supply curve intercepts, and T is a vector of implicit taxes, T' ..
o(T l' T 2' T s' T., T 6)' 	T is applied to General Motors and offshore Japanese
production. 	T 1 and 	T 2 are the implicit 	tariffs for each 	type of off-shore
Japanese 	car, 	T 1sT2' 	T s' T 4' 	T 6 are 	the 	implicit 	CAFE 	taxes 	applied 	to
each type of American car produced by GM.s 	V is a vector of implicit taxes
applied to Ford. 	V'. (V l' V 2' V S' V 4' V 6)' where VIS V 2 • 	O. 	The level
of these implicit taxes will be generated by the model.
CAFE 	standards 	are 	assumed 	to 	be 	just 	nonbinding 	in 	the 	initial
conditions (that is, that the levels reached by automobile companies under a
lower CAFE standard are the same as those they would have reached without
any 	CAFE 	standard 	at 	all), 	but 	differentially 	binding 	on 	the 	"Big 	Two"
(General Motors and Ford) if the policy is enforced.· 	This is likely to yield
an 	underestimate of deadweight 	loss (OWL), as 	OWL is a 	function 	of the
implicit tax squared. 	Crandall and Graham 5 suggest that even without relief
CAFE standards would be binding on GM and Ford, meaning that an implicit
tax already applies to these two firms. 	If CAFE standards are imposed, they
are 	assumed 	to 	be 	binding, 	and 	the 	implicit 	tax 	per 	"Big 	Two" 	car 	is
calculated 	accordingly. 	The 	system 	of 	21 	equations 	(five 	demand 	curves,
thirteen supply curves, two CAFE constraints, and one import constraint) in
2 I 	unknowns 	(five 	prices, 	thirteen 	quantities, 	and 	three 	implicit 	taxes) 	is
solved and the implicit tariff and the shadow tax per MPG for GM and Ford
are iterated until the desired qUClta and CAFE standard level are reached.
Based on past studies of the demand for automobiles we assume that a
10 percent increase in the small car price will generate a 20 percent decline
in the quantity of small cars demanded and that a 10 percent increase in the
S Assume that under one scenario the implicit tariff on Japanese cars is
S500 and the implicit CAFE tax is S300 per MPG for General Motors. 	Using
the formula for calculating implicit CAFE taxes (see below) and the MPG per
class 	in 	Table 	A·3 	yields 	an 	implicit 	tax 	vector 	T' 	• 	(500, 	500,
300-27.5-«27.5/32.45)-1), 	300-27.5-«27.5/27.42)- I), 	300-27.5-«27.5/25.31)- I» 	I::
(500, 500, - J 258, 24, 7 J 4).
4 Chrysler 	is 	assumed 	not 	to 	be 	bound 	by 	CAFE 	regulations 	in 	the
simulation. 	Its 	supply 	of 	credits 	earned 	in 	previous 	years 	is 	more 	than
sufficient to cover any likely shortfall.
6 Robert W. Crandall and John O. Graham, "The Effect of Fuel Economy
Standards 	on 	Automobile 	Safety," 	Journal 	of 	Law 	and 	Economics
(Forthcoming, J989), p. 19.
2
...

price of large 	cars will 	lower 	the 	quantity of large 	cars 	demanded 	by 	30
percent.6
The 	point elasticities of demand 	at 	the original 	1987 equilibrium are
shown in Table A-3. 	The own-price elasticity of demand for automobiles is
assumed 	to 	be 	one. (This 	is consistent 	with 	the 	results 	reported 	in 	Irvine
(1983).7) 	The cross-elasticities shown 	should 	not 	be 	interpreted 	as 	precise
figures, but merely internally consistent with the overall market demand and
the own-elasticities for each of the segments from 2 to 3. 	The method for
the derivation of the cross-elasticities is available upon request.
To 	our 	knowledge, 	no 	study 	exists 	of 	short-run 	cost 	curves 	for
automobile 	production. 	Results obtained by Friedlander el al.8 indicate that
the industry may have constant long-run marginal cost curves. 	In the short-
run, however, it seems likely that marginal costs are increasing. 	Thus, the
point elasticity of supply (marginal cost) in the model is set equal to 2 for
MY 	1989. 	This assumes that while the industry has a competitive structure,
there are short-term economic rents to be earned in the sale of automobiles.
We 	assume 	that 	given 	a 	year 	to 	prepare, automakers 	would 	be 	in 	a 	better
position to comply with a CAFE standard of 27.5 MPG in MY 	1990. 	Thus,
we assume that the supply elasticity for that year is 4.
Documents we have 	received 	from two major auto companies indicate
that 	GM 	is 	better 	situated 	than 	Ford 	to 	satisfy 	the 	27.5 	MPG 	standard.
Absent the standard, GM expects to reach 26.86 MPG in MY 1989 and 26.72
MPG in MY 1990. 	Ford expects to reach 26.6 MPG in both years. 	Thus, the
higher CAFE standard would require a "stretch" of 0.64 MPG for GM in MY
1989 and 0.78 MPG for GM in MY 	1990. 	The stretch for Ford would be 0.9
MPG in both years. 	We assume that GM and Ford meet the standard and do
not choose to pay civil penalties. 	The economic effects we generate in our
model 	are relative 	to those that would occur should 	NHTSA set the CAFE
standard for the 'relevant model years between 26.5 and 26.6 MPG.Q
Should GM prevail 	in 	its current court chaJlenge, and 	win 	additional
CAFE mileage 	credits, it expects to reach 27.1 	MPG in 	MY 	1989, and 	26.9
6 These 	sensItIvIty 	(or 	elasticity) estimates 	are 	those 	found 	in 	James
Langenfeld 	and 	Michael 	Munger, 	"The 	Impact 	of 	Federal 	Automobile
Regulations on Auto Demand," unpublished draft, Federal Trade Commission
(June 1985) and were those used in FTC Staff (1986).
7 F. 	Owen 	Irvine 	Jr., 	"Demand 	Equations 	for 	Individual 	New 	Car
Models," Southern Economic Journal (1983), 764-782.
8 A. F. Friedlander, C. Winston, and K. Wang, "Costs, Technology, and
Productivity 	in 	the 	U.S. 	Automobile 	Industry," 	Bell 	Journal 	of 	Economics
(1982), 1-20.
Q Our 	analysis 	assumes 	that 	any 	CAFE 	standard 	below 	26.6 	MPG 	is
nonbinding for all manufacturers. 	Any standard below 26.6 MPG (e.g., 26.5
MPG) could therefore be expected to have the same effects as a 26.6 MPG standard.
3

MPG 	in 	MY 	1990. 	We 	also 	compute 	the 	economic effects 	of 	the 	higher
CAFE standard under this scenario.
To 	calculate 	the 	employment 	changes 	we 	use 	data 	from 	the
Congressional 	Budget 	Office 	that 	provides 	the 	additional 	hours 	of 	work
required 	to 	produce 	an 	additional 	domestic 	automobile. lo 	From 	this
information w'e compute a coefficient that shows the change in the number
of jobs that would result from a given change in the number of each type of
automobile 	produced. 	We 	have computed 	such 	a 	coefficient for 	the 	three
types 	of cars sizes (see Table 	A·3). 	Multiplying 	these 	coefficients 	by 	the
-change 	in 	the 	sales 	of 	domestic 	small 	and 	large 	cars, 	we 	arrive 	at 	an
estimate for 	the employment changes brought about by an adjustment 	to a
27.5 	MPG 	CAFE 	standard. 	The 	employment 	effect 	is 	more 	adverse 	than
would 	be 	suggested 	solely 	by 	examination 	of 	changes 	in 	total 	automobile
production. 	This 	is 	because 	the 	production 	of 	large 	cars 	involves 	more
domestic labor than the production of small cars. 	Because on-shore assembly
requires approximately only one·third as much American labor per vehicle as
would 	on-shore 	domestic 	production 	(because 	most 	of 	the 	components 	are
manufactured 	overseas), 	we 	assume 	that 	the 	amount 	of 	domestic 	labor
required is only one-third of what it would be for similar domestic segments.
10 See 	Domestic 	Content 	Legis/ation 	and 	the 	U.S. 	Automobile 	Industry,
Subcommittee on Trade of the House Committee on Ways and Means (August
J 6, 1982), p. 34·48.
4

Table A-I
Simulation Results
Model Year 1989
GM MPG Increase: 0.64 MPG 	Ford MPG Increase: 0.90 MPG
GM Implicit l:ax c $1133/MPG 	Ford Tax - $1094/MPG
Japanese Implicit Tariff- 	$0
Price and Output Effects
(Prices in thousands and Quantities in millions)
Class 	Price 	Qty 	Pchange 	Qchange
I 	8.655 	1.734 	-0.034 	-0.014
2 	14.170 	1.242 	0.406 	0.069
3 	6.692 	1.733 	-1.681 	0.565
4 	10.898 	2.024 	0.179 	0.140
5 	15.896 	3.066 	0.819 	-0.588
Output Effects by Firms
Class 	GMll 	Ford 	Other 	GMChange FChange OthChange
I 	1.332 	0.000 	0.402 	-0.0 II 	0.000 	-0.003
2 	0.963 	0.000 	0.280 	0.054 	0.000 	0.016
3 	0.749 	0.811 	0.174 	0.333 	0.350 	-0.117
4 	0.965 	0.508 	0.552 	0.081 	0.042 	0.018
5 	1.824 	0.929 	0.314 	-0.419 	-0.199 	0.031
Welfare Effects on Consumers and Firms
(in billions of dollars)
Class 	Cons. 	Firms 	DWL 	GMChange FChange Othchange
I 	0.059 	-0.059 	0.000 	-0.046 	0.000 	-0.014
2 	-0.490 	0.490 	0.000 	0.380 	0.000 	0.110
3 	2.846 	-4.123 	1.277 	-1.814 	-1.918 	-0.391
4 	-0.338 	0.331 	0.007 	0.153 	0.081 	0.097
5 	-2.721 	2.071 	0.651 	1.199 	0.628 	0.244
Economic Welfare Changes
(in $ billion)
Consumer Change - -0.644
American Firms Change .. -1.533 	Asian Firms Change .. 0.430
GM Change .. -0.463 	Ford Change c -1.209
Chrysler Change>: 0.139 	Other Firms Change'"' -0.118
Gasoline Consumption Savings: -245 million gallons
Change in Employment(OOOs): -11.646
11 This category also includes off-shore Japanese production constrained
(potentially) by the Voluntary Restraint Agreement.
5

Table A-2
Simulation Results
Model Year 1990
GM MPG Increase • 0.78 MPG 	Ford MPG Increase • 0.90 MPG
GM Implicit tax. S822/MPG 	Ford Implicit Tax. $726/MPG
Japanese Implicit Tariff c $60
Price and Output Effects
Prices in thousands and Quantities in millions)
Class 	Price 	Qty. 	Pchange 	Qchange
1 	8.706 	1.725 	0.017 	-0.023
2 	14.104 	1.273 	0.340 	0.100
3 	6.820 	1.706 	-1.553 	0.538
4 	10.881 	2.052 	0.162 	0.168
5 	15.968 	3.013 	0.891 	-0.641
Output Effects by Firms
Class 	GM 	Ford 	Other 	GMChange FChange OthChange
1 	1.3 I 7 	0.000 	0.408 	-0.026 	0.000 	0.003
2 	0.983 	0.000 	0.290 	0.074 	0.000 	0.026
3 	0.817 	0.814 	0.075 	0.401 	0.353 	-0.216
4 	0.974 	0.511 	0.566 	0.090 	0.045 	0.032
5 	1.731 	0.932 	0.350 	-0.512 	-0.196 	0.067
Welfare Effects on Consumers and Firms
(in billions of dollars)
Class 	Cons. 	Firms 	DWL 	GMChange FChange Othchange
1 	-0.029 	0.029 	0.000 	0.022 	0.000 	0.007
2 	-0.418 	0.418 	0.000 	0.324 	0.000 	0.094
3 	2.718 	-3.506 	0.788 	-1.675 	-1.547 	-0.284
4 	-0.312 	0.3 I I 	0.001 	0.145 	0.077 	0.089
5 	-2.913 	2.369 	0.544 	1.322 	0.766 	0.282
Economic Welfare Changes
(in $ billion)
Consumer Change 0= -0.955
American Firms Change. -0.689 	Asian Firms Change 0= 0.447
GM Change IE -0.208 	Ford Change: -0.704
Chrysler Change. 0.223 	Other Firms' Change • -0.137
Gasoline Consumption Savings: -204 million gallons
Change in Employment(OOOs): -19.957
6

_...
" Table A-3
! Parameters Used in CAFE Simulation
Elasticity Table
Class 	2 	3 	4
J) Asian Small' 	-2.000 	0.243 	0.334 	0.355
2) Asian Luxury Small 0.2] 7 	-2.500 	0.125 	0.837
3) Domestic Small 	0.856 	0.446 	-2.000 	0.583
4) Domestic Lux. Sma. 	0.]65 	0.539 	0.103 	-2.500
·5) Large 	0.015 	0.083 	0.010 	0.103
Totals by Class
5
0.704
2.66]
1.160
2.237
-3.000
Class 	Price 	Quantity 	MPG 	Cars/Job
(Initial) 	(Initial)
(SOOO) 	(million)
1
2
3
4
5
8.689
13.764
8.373
10.7] 9
15.077
1.748
1.173
1.168
1.884
3.654
35.51
29.57
32.45
27.42
25.31
22.65
]9.38
7.55
6.46
5.40
Initial Quantities by Firms
(millions of units)
Constrained 	Uncstr.
Class 	GM 	Ford 	Chrysler 	Other 	Asian 	Asian
1 	0.000 	0.000 	0.000 	0.000 	1.343 	0.405
2 	0.000 	0.000 	0.000 	0.000 	0.909 	0.264
3 	0.4 ]6 	0.461 	0.150 	0.140 	0.000 	0.000
4 	0.884 	0.466 	0.534 	0.000 	0.000 	0.000
5 	2.234 	J.l28 	0.283 	0.000 	0.000 	0.000
Supply Elasticity: 2.0 (all firm~and classes, Model Year 1989)
4.0 (all firms and classes, Model Year 1990)
Source 	for 	prices: 	Ward's 	Automotive 	Yearbook, 	J988, 	PP. 	2]6-221 	and 	287-
293.
Source 	for 	Quantities 	and 	fuel 	efficiency: 	Patricia 	S. 	Hu 	and 	Linda 	S.
Williams, 	"Light 	Duty 	Vehicle 	MPG 	and 	Market 	Shares 	Report: 	1st 	Six
Months Model Year 1988," Oak Ridge National Laboratory (Forthcoming) E-41
to E-44.
7

Table A-4
Simulation Results
Model Year 1989
AltuDate SeeDario
GM MPG Increase: 0.40 MPG 	Ford MPG Increase: 0.90 MPG
GM Implicit Tax- S802.80/MPG Ford Implicit Tax - SI047.51/MPG
Japanese Implicit Tariff- SO
Price and Output Effects
(Prices in thousands and Quantities in millions)
Class 	Price 	Qty 	Pchange 	Qchange
1 	8.625 	1.722 	-0.064 	-0.026
2 	13.994 	1.212 	0.230 	0.039
3 	6.859 	1.643 	-1.514 	0.475
4 	10.745 	2.006 	0.026 	0.122
5 	15.629 	3.251 	0.552 	-0.403
Output Effects by Firms
Class 	GM 	Ford 	Other 	GMChange FChange OthChange
1 	1.323 	0.000 	0.399 	-0.020 	0.000 	-0.006
2 	0.939 	0.000 	0.273 	0.030 	0.000 	0.009
3 	0.632 	0.825 	0.186 	0.216 	0.364 	-0.]05
4 	0.955 	0.5]4 	0.537 	0.071 	0.048 	0.003
5 	2.003 	0.945 	0.304 	-0.240 	-0.183 	0.02]
Welfare Effects on Consumers and Firms
(in billions of dollars)
Class 	Cons. 	Firms 	DWL 	GMChange FChange Othchange
1 	0.]]2 	-0.112 	0.000 	-0.086 	0.000 	-0.026
2 	-0.275 	0.275 	0.000 	0.213 	0.000 	0.062
3 	2.425 	-3.403 	0.977 	-1.193 	-1.849 	-0.361
4 	-0.038 	0.024 	0.0]4 	0.010 	0.000 	0.0]4
5 	-1.888 	1.581 	0.307 	1.009 	0.410 	0.162
Economic Welfare Changes
(in billions of dollars)
Consumer Change'"' 0.336
American Firms Change II: -1.624 	Asian Firms Change II: 0.]63
GM Change II: -0.174 	Ford Change II: -1.439
Chrysler Change c -0.011 	Other Firms' Change'" -0.174
Gaso]ine Consumption Savings: -34] million gallons
Change in Employment (OOOs): 7.490
8

."
Table A-5
Simulation Results
Model Year 1990
Alternathe Scenario
GM MPG Increase: 0.60 MPG
GM Implicit Tax - S687.69/MPG
Japanese Implicit Tariff- SO
Ford MPG Increase: 0.90 MPG
Ford Implicit Tax - $ 691.26/MPG
Price and Output Effects
(Prices in thousands and Quantities in millions)
Class 	Price 	Qty. 	Pchange 	Qchange
1 	8.661 	1.725 	-0.028 	-0.023
2 	13.987 	1.249 	0.223 	0.076
3 	6.917 	1.646 	-1.456 	0.478
4 	10.779 	2.035 	0.060 	0.151
5 	15.775 	3.147 	0.698 	-0.507
Output Effects by Firms
Class 	GM 	Ford 	Other 	GMChange FChange OthChange
1 	1.325 	0.000 	0.400 	-0.018 	0.000 	-0.005
2 	0.968 	0.000 	0.281 	0.059 	0.000 	0.017
3 	0.737 	0.820 	0.089 	0.321 	0.359 	-0.202
4 	0.975 	0.514 	0.546 	0.091 	0.048 	0.012
5 	1.872 	0.939 	0.335 	-0.37 J 	-0.189 	0.052
Welfare Effects on Consumers and Firms
(in billions of dollars)
Class 	Cons. 	Firms 	DWL 	GMChange FChange Othchange
1 	0.049 	-0.049 	0.000 	-0.038 	0.000 	-0.011
2 	-0.270 	0.270 	0.000 	0.210 	0.000 	0.061
3 	2.433 	-3.095 	0.662 	-1.332 	-1.487 	-0.276
4 	-0.107 	0.J02 	0.004 	0.046 	0.024 	0.032
5 	-2.339 	2.003 	0.336 	1.191 	0.596 	0.216
Economic Welfare Changes
(in S billion)
Consumer Change - -0.234
American Firms Change = -0.856
GM Change- -0.095
Chrysler Change - 0.105
Change in Employment (OOOs): -6.647
Gasoline Savings: -288 million gallons
Asian Firms Change = 0.221
Ford Change - -0.866
Other Firms Change - -0.133
9

.'
II. The Mathematics of Harmonic Anraeing
Assume that a 	firm 	makes only 	two types of cars; a 	large 	relatively
fuel-inefficient 	model, 	and 	a 	small 	relatively 	(uel-efficient 	model. 	As
discussed in the comments above, the explicit fine, F, on a firm for failing
to reach the CAFE standard is equal to
if the firm does not reach the standard, where S is the level of the CAFE
. standard, 	QL and 	Qs are 	the 	number of large and 	small cars sold 	by 	the
firm, 'and MPG is the firm's average fuel efficiency.
The measurement of a firm's CAFE level was not defined as the simple
average of a manufacturer's fleet MPG. 	Instead, a firm's CAFE level is the
harmonic average of that firm's fleet MPG.12 	The harmonic average for the
firm is calculated by
where ML and M s are the fuel efficiencies of the two types of cars.
Using the 	harmonic average, 	the marginal 	CAFE fine 	to the 	firm 	of
producing a car of type I is
(5) 	dF /dQl • SO*(S-2MPG+(MPG2/M s »
Assume 	now 	that 	the 	standards 	are 	binding. 	In 	that 	case 	MPG=S, 	the
explicit fine of $50 per MPG per car is replaced by a shadow tax L and the
implicit CAFE tax on a car of type 1 becomes
(6) 	dF/dQl • L *S*«S/Ms)-l)
where L is the value of the constraint discussed above. IS
12 Public Law 46:15-2003. 	One property of a harmonic average is that
if it is doubled fuel consumed by driving the same number of miles in each
type of car is halved.
IS The marginal fine derived above presents a 	more difficult problem
to 	manufacturers 	than 	would 	occur 	with 	a 	standard 	based 	on 	simple
averaging. 	Consider a 	firm 	that 	is deciding 	whether or 	not 	to 	produce an
additional 	car 	with 	fuel 	efficiency equal 	to 	20.0 	MPG 	where 	the 	binding
CAFE standard is 	27.5 MPG. 	If simple averaging were used, the firm would
have to offset that additional unit by producing one car with fuel efficiency
of 35.0 	MPG 	(or the equivalent). 	Under harmonic averaging, however, to
produce another unit of 20.0 MPG, the firm must also produce the equivalent
of one 	unit 	with 	fuel 	efficiency of 44.0 MPG. 	Thus, compared 	to simple
averaging, 	the 	harmonic 	averaging 	used 	makes 	the 	CAFE 	standard 	more
difficult to meet.
10