6
THE AUTOMOBILE, FUEL ECONOMY, AND THE CONSUMER

To understand how the automobile industry might be affected by fuel economy standards, it is important to understand the automobile consumer. No matter what the automobile companies do, the consumer must voluntarily agree to purchase from the menu of choices offered. This chapter examines what motivates the consumer, how consumer choices have changed over the past two decades, and how one might evaluate the impact of fuel economy standards on the consumer.

THE AUTO MARKET IS A REPLACEMENT MARKET

As mentioned in Chapter 5, the U.S. automotive market is mature; to a very large extent, consumers purchase new cars to replace cars that have worn out. Figure 6-1 shows the additions and subtractions (sales and scrappage) of cars and light trucks in the United States between 1970 and 1989. The scrappage numbers represent automobiles, trucks, and buses, with automobiles accounting for about 80 percent in 1989. Throughout the period, the ratio of licensed drivers to automobile registrations remained virtually unchanged at a value of 1.2; the ratio of licensed drivers to automobiles on the road has changed from 1.37 in 1978 to 1.34 in 1989 (Motor Vehicle Manufacturers Association [MVMA], 1991). Figure 6-2 shows registrations and automobiles on the road in recent years, as well as the U.S. population between 16 and 65 years of age, historically and projected through 2020. The size of the latter group-approximately the set of licensed drivers—is projected to grow from 1991 to 2010, level off at 2010, and then decline.

While sales growth in terms of number of vehicles has largely leveled off, sales in terms of value have not. Figure 6-3 shows the price of new cars and median family earnings, expressed in constant 1970 dollars, for the period 1971-1989.1 Three prices are shown. One is the average new-car price—it clearly went up over the period, but

1  

In nominal terms, the average transaction price on a new car rose from $4,950 to $16,012 between 1975 and 1990.



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Automotive Fuel Economy: How Far Should We Go? 6 THE AUTOMOBILE, FUEL ECONOMY, AND THE CONSUMER To understand how the automobile industry might be affected by fuel economy standards, it is important to understand the automobile consumer. No matter what the automobile companies do, the consumer must voluntarily agree to purchase from the menu of choices offered. This chapter examines what motivates the consumer, how consumer choices have changed over the past two decades, and how one might evaluate the impact of fuel economy standards on the consumer. THE AUTO MARKET IS A REPLACEMENT MARKET As mentioned in Chapter 5, the U.S. automotive market is mature; to a very large extent, consumers purchase new cars to replace cars that have worn out. Figure 6-1 shows the additions and subtractions (sales and scrappage) of cars and light trucks in the United States between 1970 and 1989. The scrappage numbers represent automobiles, trucks, and buses, with automobiles accounting for about 80 percent in 1989. Throughout the period, the ratio of licensed drivers to automobile registrations remained virtually unchanged at a value of 1.2; the ratio of licensed drivers to automobiles on the road has changed from 1.37 in 1978 to 1.34 in 1989 (Motor Vehicle Manufacturers Association [MVMA], 1991). Figure 6-2 shows registrations and automobiles on the road in recent years, as well as the U.S. population between 16 and 65 years of age, historically and projected through 2020. The size of the latter group-approximately the set of licensed drivers—is projected to grow from 1991 to 2010, level off at 2010, and then decline. While sales growth in terms of number of vehicles has largely leveled off, sales in terms of value have not. Figure 6-3 shows the price of new cars and median family earnings, expressed in constant 1970 dollars, for the period 1971-1989.1 Three prices are shown. One is the average new-car price—it clearly went up over the period, but 1   In nominal terms, the average transaction price on a new car rose from $4,950 to $16,012 between 1975 and 1990.

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Automotive Fuel Economy: How Far Should We Go? FIGURE 6-1 Trends in the sale and scrappage of automobiles and light trucks. SOURCE: MVMA (1991). FIGURE 6-2 U.S. population between 16 and 65 years of age, historical and projected, and automobile registrations. SOURCE: Bureau of the Census (1989, 1991).

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Automotive Fuel Economy: How Far Should We Go? FIGURE 6-3 Family income and new-car expenditures in constant 1970 dollars. The line labeled "without safety/emission equipment" represents a 1967comparable car. The line labeled "with safety/emissions equipment" reflects the impact of such equipment on the cost of a 1967-comparable car. SOURCE: Based on MVMA (1991), corrected for inflation using the Consumer Price Index. incomes did not. Also shown is the price of a "constant-equipped" car, often called a 1967-comparable car. (Consumers cannot typically buy a 1967 constant-equipped new car, but the figure provides an estimate of what it would cost.) The third price shown is the price for a constant-equipped car, but with the cost of the emissions and safety equipment that has been required over time added on. The price of 1967-comparable cars has dropped significantly over the past two decades, even including mandated emissions and safety equipment. But consumers have chosen to spend more and more on their vehicles. 2 Although some of the increase in expenditure may have been to attain additional fuel economy, undoubtedly much of it was to purchase greater performance, quality, and comfort. 2   Some of the increase in expenditure may be due to the movement in the industry away from pricing options individually and to selling options as packages.

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Automotive Fuel Economy: How Far Should We Go? Increased expenditures on the automobile "package" should not be viewed as frivolous enhancement of otherwise totally adequate vehicles. Consumers view cars in a substantially different way today than they did several decades ago. The car is more than just a means to get from one place to another. The addition of comfort options to a car makes it a much more functional, multipurpose environment, which is particularly appropriate as people spend more and more commuting time in vehicles. Further, consumers have demanded some features that are societally desirable, such as improved occupant safety. Quality has also risen, which justifies additional expenditures. Other features have been mandated by government to improve air quality, safety, and fuel economy. And others are of a performance nature. Over time, demand is expected to continue to grow for some of these options (such as safety). The demands, however, may be in direct conflict with those for higher fuel economy. New car buyers today are typically replacing a relatively new vehicle, usually one that is three to six years old, which they trade in toward the new car. It is easy for them to defer buying new vehicles, which is one reason for the cyclic nature of automobile demand. The car traded in becomes transportation for another driver; each vehicle has about three owners before it is scrapped. More old vehicles are on the road than has been the case in the past. The portion of cars and trucks in the United States over the age of 12 climbed from 11.9 to 20.8 percent for cars and from 18.4 to 27.6 percent for trucks between 1980 and 1990 (MVMA, 1991). Whatever the explanation for the increasing age of the fleet, the result is that additions of new cars decrease as the average age of the fleet increases; slow scrappage of cars leads to fewer purchases of new cars. There is some suggestion that consumers will not continue to increase their demand for optional equipment and performance. Many consumers are faced with imperfect capital markets in the sense that the size of monthly payments on a new car loan (amortized over less than the car's lifetime) is a constraint on how much they can spend on a new car.3 Over half of all new-car purchases are financed with new-car loans (62 percent in 1990; MVMA, 1991). Figure 6-4 shows the average monthly payment for those who financed their new-car purchase between 1979 and 1989. Because of an increase in the maximum possible length of the term of the loan (from four to five years) in the early 1980s, the average monthly payment has not gone up as rapidly as new-car prices. The maximum loan period is market driven, that is, it is associated with the rate of depreciation of the automobile, which in turn is influenced in part by its lifetime and durability and the demand for the automobile in the used car market. For obvious reasons, the outstanding principal on an automobile loan should not, in general, exceed the value of that automobile in the used car market. In some cases, five-year loans have allowed borrowers to go "upside-down" in their loans—the outstanding balance on the loan exceeds the value of the automobile—for much of the loan term. This is obviously not desirable from the lender's perspective 3   That the size of monthly payments is a "constraint" on the ability of some consumers to buy a new car was expressed to the committee by several of the automobile manufacturers.

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Automotive Fuel Economy: How Far Should We Go? FIGURE 6-4 Average monthly payment for new-car loans (1989 dollars). SOURCE: Based on MVMA (1991). and has limited the lenders' willingness to extend loan terms further. As a result, further price increases in excess of the growth in income will be more difficult for consumers to handle than were the increases in the 1980s. In sum, analysis of the available information suggests that the total number of sales of new vehicles will not grow significantly between now and 2006. Moreover, although the prices of new cars have increased significantly in constant dollar terms since the 1970s, there are reasons to believe that future price increases will not be readily accommodated by consumers. BALANCING FUEL COST, PURCHASE PRICE, AND VEHICLE CHARACTERISTICS In purchasing a motor vehicle, consumers consider a wide variety of attributes, including fuel economy, performance, safety, interior volume, and accessories. Fuel

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Automotive Fuel Economy: How Far Should We Go? economy provides virtually no direct benefit other than decreasing the cost of driving.4 When the price of fuel increases, consumers are willing to pay more for fuel economy; when the price drops, consumers are less willing to pay for fuel economy. The price of gasoline thus influences the automobile purchase decision. Consumers evaluate how much fuel economy to buy in a new car and how much of other vehicle characteristics to buy (e.g., safety, performance). Figure 6-5 illustrates how the rational consumer trades off the increased cost of technology to improve automobile fuel economy with the resulting fuel savings. Holding all other characteristics of a vehicle constant, line 3 on Figure 6-5 shows how the hypothetical price of a car increases with improved fuel economy (miles per gallon, or mpg).5 (The qualitative conclusions drawn from the figure are not very sensitive to specific assumptions about cost.) Also shown in the figure is the present value of the lifetime stream of gasoline expenditures at two gasoline prices, $1.00 a gallon and $3.00 FIGURE 6-5 Hypothetical total car and net present value (NPV) fuel costs (assumes 10,000 miles traveled per year, a 10-year automobile life, and a discount rate of 10 percent a year). 4   Consumer interest in fuel economy is also affected by the availability of fuel. The gasoline lines of the 1970s created a wave of consumer interest in small, high fuel economy cars. Interruption in gasoline supply thus can have an immediate impact on buyer interest in fuel economy. 5   The curve starts at the 1990 average price of a new car ($16,012) (MVMA, 1991) at a fuel economy of 29 mpg. Fuel economy is assumed to increase to 39.5 mpg at an additional cost of $2,500.

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Automotive Fuel Economy: How Far Should We Go? a gallon (lines 1 and 2).6 The purchase price and gasoline costs are combined into a curve of total costs (excluding other operating costs) in lines 4 and 5 (corresponding to the two gasoline prices). Figure 6-5 illustrates three points. First, the fuel economy level that results in the lowest total cost (the optimum for the consumer) is not too dissimilar for the two gasoline prices (30 mpg for $1.00 per gallon and 33 mpg for $3.00 per gallon). This suggests that gasoline price is not a very powerful lever for increasing the efficiency of the new-car fleet. Second, the total cost curve is very flat in the vicinity of the optimal fuel economy level—total costs are relatively insensitive to the fuel economy level of the automobile. Thus, the consumer would not be expected to devote much effort to determining the best level of fuel economy to acquire. For curve 5, the difference in total cost between a 33-mpg car and a 39-mpg car is approximately $1,000, less than 5 percent of total costs. Because the economic benefits of improved fuel economy are not dramatic, consumers are behaving rationally in not demanding improved fuel economy, and manufacturers understandably may be reluctant to take significant risks to develop more fuel-efficient vehicles. Indeed, as will be discussed in Chapter 9, the technology-forcing dimension of CAFE-style regulation is one of its principal benefits. Finally, because of the nature of the fuel economy measure (in miles per gallon), the total fuel bill does not drop as dramatically as one might expect as fuel economy moves from 29 to 40 mpg. This is because fuel use is proportional to the reciprocal of miles per gallon. Thus, the gasoline saved in going from 20 to 25 mpg is about the same as that saved in going from 30 to 43 mpg. Gasoline price not only affects the consumer's interest in fuel economy, but also his or her interest in other automobile characteristics. When the fuel price dropped substantially in the mid-1980s, the cost of owning and operating a car dropped, as well as the additional cost associated with increased performance (since performance is inversely related to fuel economy). In essence, there are many features a buyer would like to include in his or her vehicle—safety, roominess, maneuverability, creature comforts, acceleration, speed, and durability. All these features add to the initial price or operating costs (particularly fuel) of a car. Inevitably the consumer makes tradeoffs. As fuel prices drop, the consumer values fuel economy less and may buy more of these other features.7 6   The figure assumes 10,000 miles per year of driving, a 10-year automobile life, and a discount rate of 10 percent per year. 7   Another factor affecting consumer purchases is disposable income. As incomes rise, people may wish to buy more automobile (not necessarily more units, but more in terms of features). If an automobile is a luxury good in the sense that as incomes rise, people spend proportionally more on automobiles, then demand can be expected to rise even more rapidly than incomes. In any event, if incomes go up in the United States, one can expect to see increased demand for automobiles, in terms of value.

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Automotive Fuel Economy: How Far Should We Go? Gasoline price also affects vehicle usage. When the price of gasoline increases, the cost per mile of transportation services rises. The consumer can and will respond by reducing miles traveled. Figure 6-6 shows annual vehicle miles traveled per vehicle versus the price of gasoline. Although this figure does not reflect other factors that influence miles traveled, it does show the effect on miles traveled of changes in the price of gasoline.8 THE AGING POPULATION MAY DEMAND FEWER SMALL CARS The mix of cars sold in the United States has changed substantially over the past two decades. Figure 1-5, in Chapter 1, shows the allocation of the fleet among light trucks and four automobile classes for model years 1975-1991. Clearly, there has been a shift away from larger cars, especially in the late 1970s, coinciding with the last of that decade's two oil shocks. One is tempted to infer from Figure 1-5 that there will not be a noticeable growth in sales of larger cars. The demography of the U.S. population suggests, however, that this trend may increase somewhat. FIGURE 6-6 Annual vehicle miles traveled (VMT) per passenger car in relation to the price of gasoline (1976-1988). SOURCE: Based on Oak Ridge National Laboratory (1991). 8   There is considerable variation in estimates of the price sensitivity (elasticity) of vehicle miles traveled. Recent studies suggest very inelastic demand, in the range of -0.05 to -0.2 (Gately, 1990; Greene, in press), whereas earlier studies suggest a range of -0.3 to -0.9 (Dahl, 1986; Leone and Parkinson, 1990). (The price elasticity of miles traveled is the ratio of the percentage change in vehicle miles traveled to the percentage change in fuel price.)

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Automotive Fuel Economy: How Far Should We Go? Figure 6-7 shows how the population is expected to age over the coming decade and beyond. Based on Census Bureau projections, the number of people aged 35 to 54 years will increase substantially and the number aged 25 to 34 years will decline. These demographic changes may affect aggregate consumer preferences. FIGURE 6-7 Age distribution of the U.S. population, 1987, 2000, 2010, 2030. SOURCE: Bureau of the Census (1989).

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Automotive Fuel Economy: How Far Should We Go? Figure 6-8 shows current consumer tastes by age group. Young drivers (under age 34) clearly choose economy cars. As purchasers get older, they choose midsize cars. And older people (over age 55) clearly prefer large cars. The youngest people are typically childless and thus require room for only one or two people in a vehicle. As they move into their child-rearing years, they require a larger car to transport a family. As they age, they could go back to small cars, but historically they have not.9 Demographic trends and the age-based buying preferences of the current population suggest the possibility of an upsurge in demand for larger cars and a reduction in demand for smaller cars, all else being equal. This is not to suggest that current baby boomers will demand cars as large as their parents did, only that they may not move back to small cars. There is an alternative hypothesis, however—namely, that there has been a generational shift in tastes. One might argue that the current younger population is fundamentally different from the older population and will not make the move to large cars as they age. The demographic effects on the car market thus remain somewhat uncertain. FIGURE 6-8 Car buyers by age group. SOURCE: Presented to the Impacts Subgroup of the Committee on Fuel Economy of Automobiles and Light Trucks, September 16, 1991, by Chrysler Corporation based on data from Consumer Attitude Research (1991). 9   There are several reasons why older people might prefer larger cars. Larger cars are generally safer. If age decreases the ability to drive, due to slowed reaction times and the like, then the likelihood of an accident will increase and a logical response is to purchase a safer car (at least for those in the larger car). A second factor is entry and egress, which are easier in large cars. A third factor is income—older people have more discretionary income and thus may be inclined to purchase a luxury vehicle.

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Automotive Fuel Economy: How Far Should We Go? SHIFTS IN AGGREGATE CONSUMER PREFERENCES Two other trends in consumer preferences warrant comment. In the early 1980s there was a dramatic shift to light trucks—pickup trucks, vans, and utility vehicles. A major reason for this shift, at least initially, was that light trucks provide cheaper transportation than automobiles. Insurance was cheaper because it was based on historical use, which was largely commercial. Further, presumably because of their largely commercial use and less stringent environmental, emissions, and safety regulations, some categories of light trucks could be obtained in very basic versions without costly options. Other features of trucks also appealed to people, such as high seating. The public interest in light trucks does bear on fuel economy standards. Although some uses of trucks require significant performance—for example, for commercial use and hauling purposes—many light trucks are simply used as automobiles. Further, the automotive industry created new types of trucks in the 1980s, particularly minivans, which are used in the same way as some categories of automobiles. But light trucks have been subject to a different fuel economy standard than automobiles. If this continues, and there is an increase in the use of these vehicles, a growing portion of the fleet will be subject to less stringent standards than automobiles, and fleet fuel economy attainments will be reduced. Another trend over the past few decades relates to optional equipment. As Figure 6-3 indicated, consumers have chosen to purchase more automobile when they buy a new vehicle. How this translates into optional purchases of equipment is suggested in Table 6-1. Many of the options negatively affect fuel economy through increased weight and through energy consumption. IMPACTS OF MANDATED FUEL ECONOMY ON THE CONSUMER Probably the most subtle impacts of mandated fuel economy are those associated with the consumer. In the current marketplace, the consumer examines the features of new and used automobiles and the anticipated price of gasoline and decides whether to purchase an automobile and which characteristics to seek. Having acquired an automobile, the consumer decides how much to drive it. Fuel economy enters into the decision in terms of trading off an initial payment for fuel economy with a stream of payments for gasoline over the life of the car, taking into account the value of the car when the consumer disposes of it.10 10   A car that has lower fuel economy will, all else being equal, have lower resale value. This lower resale value affects the decision to purchase a new car.

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Automotive Fuel Economy: How Far Should We Go? TABLE 6-1 Change in Optional Equipment for Selected Model Year Passenger Cars (in percentage of cars sold) Options 1971 1980 1985 1990 Automatic transmission 91.1 82.7 86.3 88.4 Power steering 82.5 83.7 92.3 97.3 Power brakes (2- or 4-wheel disc) 59.3 64.6 95.6 92.4 Antilock brakes — — — 7.6 Power seats 10.6 16.3 33.7 36.7 Air-conditioning (manual temperature control) 57.6 65.3 72.4 71.6 Air-conditioning (automatic temperature control) 5.8 7.7 14.8 20.3 Power windows 20.7 23.3 45.2 58.6 Driver airbag — — — 29.7   SOURCE: MVMA (1991). The propriety of government intervention in the market to require enhanced fuel economy might be guided in part by consideration of whether the consumer typically makes a rational choice in trading off fuel economy and the price of gasoline. While the evidence is far from complete, analyses of the prices of used cars (Kahn, 1986) suggest that the consumer does appropriately trade off the cost of fuel economy with the cost of gasoline in used car purchases. Difiglio et al. (1990) have calculated that the difference between such a rational consumer decision on fuel economy and a distorted one is on the order of 2 mpg.11 As was noted earlier, however, total costs of owning and operating an automobile are relatively insensitive to fuel economy. Thus, because consumers must expend effort to determine the optimum in the trade-off of vehicle cost and fuel economy, error and even bias in consumer decisions may result. A second important consideration concerns the public and private costs of gasoline consumption. While the consumer behaves on the basis of what he or she pays at the gas pump, the true societal costs of gasoline consumption may be higher. The costs of pollution and maintaining oil security are two costs directly attributable to gasoline 11   In particular, Difiglio et al. (1990) assume that a rational decision involves amortizing a fuel economy investment over 10 years at a 10 percent real discount rate. They assume a distorted decision on fuel economy involves amortization over four years at the same discount rate.

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Automotive Fuel Economy: How Far Should We Go? consumption that do not appear in its price. These costs are difficult to quantify, but the security costs of oil have been estimated at anywhere from nothing to $3 per gallon (Broadman, 1986). If consumers do not pay the true cost of gasoline, they will undervalue fuel economy. Consequently, some mandated increase in fuel economy may enhance consumer well-being in the sense that the increased cost of fuel efficiency is justified by the societal and individual benefits of consuming less fuel. It must be acknowledged, however, that raising the fuel economy standard above what the market would demand on its own has an impact on the consumer. For a particular car, a nonmarket-based increase in fuel economy has a cost.12 As a result of standards, the consumer is faced with a menu of cars with increased prices (net of fuel costs) relative to the situation in which there is no mandated fuel economy standard. The consumer may make the same car choice before and after the price rise, in which case the additional cost of fuel economy comes directly out of the consumer's pocket. The more likely situation is that the consumer will look at the menu of choices and decide to take less of some characteristic, such as performance, size, or even safety. In this case, the consumer loss is somewhat less, but it is still a loss. To summarize, as the mandated fuel economy standard is gradually raised above what would prevail without a standard, consumers first benefit, due to the fact that gasoline may be underpriced (for reasons stated above), and then they start to pay extra, either through higher car prices or through less desirable car characteristics. The full implications of the effects of fuel economy standards on the consumer are discussed in Chapter 9. FINDINGS AND CONCLUSIONS The available information suggests that total annual sales of new cars will only grow moderately over the term of this study. The price of gasoline should enter into the consumer's decision to purchase a new vehicle. The rational consumer should trade off the additional cost of a new car that is associated with improved fuel economy against the resulting fuel savings. But gasoline price is not a very powerful lever for increasing the fuel economy of the new fleet. Because the total cost curve is relatively flat in the vicinity of the optimal fuel economy level, the consumer should not be expected to exert much effort to find the optimum, and the manufacturer has little incentive to take significant risks to produce cars that provide more fuel efficiency. As a result of the aging of the U.S. population, there could be an upsurge in demand for larger cars in the future, with adverse consequences for fuel economy. Such matters are not conclusively resolved by the available data, however; the baby-boomers may have different tastes than their parents.   12   If there are costless ways of enhancing fuel economy, they should always be pursued.

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Automotive Fuel Economy: How Far Should We Go?   Since the early 1980s, there has been a major shift in consumer demand toward light trucks to serve the same purposes as automobiles. Because light trucks have lower fuel economy on average than automobiles, the trend has adversely affected fuel economy goals. Moreover, there has been increasing consumer demand for options that negatively affect fuel economy. Consumer decisions on the desirable fuel economy level in new cars are based on current and projected costs of gasoline. To the extent that this price is artificially low—that is, it does not reflect pollution, security, or other societal costs—the consumer will not choose a sufficient level of fuel economy when purchasing a new vehicle. Higher gasoline prices will cause people to drive less and thus will reduce gasoline consumption. Higher gasoline prices will also induce people to buy vehicles with greater fuel economy, although the effect may be modest.  

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Automotive Fuel Economy: How Far Should We Go? REFERENCES Broadman, H.J. 1986. The social cost of imported oil. Energy Policy June:242-252. Bureau of the Census. 1989. Projections of the Population of the United States, by Age, Sex, and Race: 1988 to 2080. Current Population Reports, Series P-25, No. 1014. Washington, D.C.: U.S. Government Printing Office. Bureau of the Census. 1991. Statistical Abstract of the United States . 111th ed. Washington, D.C.: U.S. Government Printing Office. Consumer Attitude Research (C.A.R.). 1991. C.A.R. Report. 2nd qtr. Birmingham, Mich. Dahl, C. 1986. Gasoline demand survey. Energy Journal (7):67-82. Difiglio, C., K.G. Duleep, and D. Greene. 1990. Cost effectiveness of future fuel economy improvements. Energy Journal 11(1):65-86. Gately, D. 1990. The U.S. demand for highway transportation and motor fuel. Energy Journal 11(3):59-73. Greene, D. In press. Vehicle use and fuel economy: How big is the rebound effect? Energy Journal, forthcoming. Heavenrich, R.M., J.D. Murrell, and K.H. Hellman. 1991. Light-duty Automotive Technology and Fuel Economy Trends Through 1991. Control Technology Applications Branch, EPA/AA/CTAB/91-02. Ann Arbor, Mich.: U.S. Environmental Protection Agency. Kahn, J.A. 1986. Gasoline prices and the used automobile market: A rational expectations asset price approach. Quarterly Journal of Economics May:323-339. Leone, R.A., and T.W. Parkinson. 1990. Conserving Energy: Is There a Better Way? A Study of Corporate Average Fuel Economy Regulation . Washington, D.C.: Association of International Automobile Manufacturers. Motor Vehicle Manufacturers Association (MVMA). 1991. Facts & Figures '91. Washington, D.C. Oak Ridge National Laboratory. 1991. Transportation Energy Data Book . 11th ed. ORNL-6649. Oak Ridge, Tenn.