From: William Charmley/AA/USEPA/US 

To: "Achanta, Chandana L." <Chandana_L._Achanta@omb.eop.gov> 

Cc: james.tamm@dot.gov, Maureen Delaney/DC/USEPA/US@EPA, rebecca.yoon@dot.gov, 

Robin Moran/AA/USEPA/US@EPA, steve.wood@epa.gov, Kathryn 

Sargeant/AA/USEPA/US@EPA 

Date: 03/29/2010 10:11 PM 

Subjec

t: 

Edits to preamble section III.H.5: Impact on US Veicle Sales and Payback Period 

Chandana - 

attached are the suggested edits to the preamble section III.H.5 regarding the vehicle sales 

impact in response to the suggested edits from OMB on Friday. We have added the same text 

inserts to our RIA discussion on this topic 

Thanks 

Bill Charmley 

[attachment "Preamble III.H.5 on sales impact estimates.doc" deleted by Tad 

Wysor/AA/USEPA/US] 
1 

[Section III.H.5] 

5. Impacts on U.S. Vehicle Sales and Payback Period

a. Vehicle Sales Impacts 

 

 This analysis compares two effects. On the one hand, the vehicles will become 

more expensive, which would, by itself, discourage sales. On the other hand, the vehicles 

will have improved fuel economy and thus lower operating costs. If consumers do not 

accurately compare the value of fuel savings with the increased cost of fuel economy 

technology in their vehicle purchase decisions, as discussed in Preamble III.H.1, they will 

continue to behave in this way after this rule. If auto makers have accurately gauged how 

consumers consider fuel economy when purchasing vehicles and have provided the 

amount that consumers want in vehicles, then consumers should not be expected to want 

the more fuel-efficient vehicles. After all, auto makers would have provided as much 

fuel economy as consumers want. If, on the other hand, auto makers underestimated 

consumer demand for fuel economy, as suggested by some commenters and discussed in 

Preamble Section III.H.1 and RIA Section 8.1.2, then this rule may lead to production of 

more desirable vehicles, and vehicle sales may increase. This assumption implies that 

auto makers have missed some profit-making opportunities. 

The methodology EPA used for estimating the impact on vehicle sales is 

relatively straightforward, but makes a number of simplifying assumptions. According to 

the literature, the price elasticity of demand for vehicles is commonly estimated to be -

1.0.1

 In other words, a one percent increase in the price of a vehicle would be expected 

to decrease sales by one percent, holding all other factors constant. For our estimates, 

EPA calculated the effect of an increase in vehicle costs due to the GHG standards and 

assumes that consumers will face the full increase in costs, not an actual (estimated) 

change in vehicle price. (The estimated increases in vehicle cost due to the rule are 

discussed in Section III.H.2) This is a conservative methodology, since an increase in 

cost may not pass fully into an increase in market price in an oligopolistic industry such 

as the automotive sector.2

 EPA also notes that we have not used these estimated sales 

impacts in the OMEGA Model. 

Although EPA uses the one percent price elasticity of demand for vehicles as the 

basis for our vehicle sales impact estimates, we assumed that the consumer would take 

into account both the higher vehicle purchasing costs as well as some of the fuel savings 

benefits when deciding whether to purchase a new vehicle. Therefore, the incremental 

 

1

 Kleit A.N., 1990. “The Effect of Annual Changes in Automobile Fuel Economy Standards.” 

Journal of Regulatory Economics 2: 151-172 (Docket EPA-HQ-OAR-2009-0472-0015); McCarthy, 

Patrick S., 1996. “Market Price and Income Elasticities of New Vehicle Demands.” Review of Economics 

and Statistics 78: 543-547 (Docket EPA-HQ-OAR-2009-0472-0016); Goldberg, Pinelopi K., 1998. “The 

Effects of the Corporate Average Fuel Efficiency Standards in the U.S.,” Journal of Industrial Economics

46(1): 1-33 (Docket EPA-HQ-OAR-2009-0472-0017). 

2

 See, for instance, Gron, Ann, and Deborah Swenson, 2000. “Cost Pass-Through in the U.S. Automobile 

Market,” Review of Economics and Statistics 82: 316-324 (Docket EPA-HQ-OAR-2009-0472-0007). 

Deleted: , which makes them more 

attractive to consumers. The basic 

question is, then, which effect dominates? 
2 

cost increase of a new vehicle would be offset by reduced fuel expenditures over a certain 

period of time (i.e., the “payback period”). For the purposes of this rulemaking, EPA 

used a five-year payback period, which is consistent with the length of a typical new 

light-duty vehicle loan.3

 The one commenter on this analysis stated that use of the fiveyear payback period was reasonable. This approach may not accurately reflect the role of 

fuel savings in consumers’ purchase decisions, as the discussion in Section III.H.1 

suggests. If consumers consider fuel savings in a different fashion than modeled here, 

then this approach will not accurately reflect the impact of this rule on vehicle sales. 

This increase in costs has other effects on consumers as well: if vehicle prices 

increase, consumers will face higher insurance costs and sales tax, and additional finance 

costs if the vehicle is bought on credit. In addition, the resale value of the vehicles will 

increase. EPA received no comments on these adjustments. The only change to these 

adjustments between the NPRM and this discussion is an updating of the interest rate on 

auto loans. EPA estimates that, with corrections for these factors, the effect on consumer 

expenditures of the cost of the new technology should be 0.914 times the cost of the 

technology at a 3% discount rate, and 0.876 times the cost of the technology at a 7% 

discount rate. The details of this calculation are in the RIA, Chapter 8.l. 

Once the cost estimates are adjusted for these additional factors, the fuel cost 

savings associated with the rule, discussed in Section III.H.4, are subtracted to get the net 

effect on consumer expenditures for a new vehicle. With the assumed elasticity of 

demand of -1, the percent change in this “effective price,” estimated as the adjusted 

increase in cost, is equal to the negative of the percent change in vehicle purchases. The 

net effect of this calculation is in Table III.H.5-1 and Table III.H.5-2. The values have 

changed slightly from the NPRM, due to changes in fuel prices and fuel savings, 

technology costs, and baseline vehicle sales projections, in addition to the adjustment in 

financing costs. 

The estimates provided in Table III.H.5-1 and Table III.H.5-2 are meant to be 

illustrative rather than a definitive prediction. When viewed at the industry-wide level, 

they give a general indication of the potential impact on vehicle sales. As shown below, 

the overall impact is positive and growing over time for both cars and trucks. Because 

the fuel savings associated with this rule are expected to exceed the technology costs, the 

effective prices of vehicles (the adjusted increase in technology cost less the fuel savings 

over five years) to consumers will fall, and consumers will buy more new vehicles. As a 

result, the lower net cost of the vehicles is projected to lead to an increase in sales for 

both cars and trucks. 

 

3

 As discussed further in Section III.H.1, there is not a consensus in the literature on how consumers 

consider fuel economy in their vehicle purchases. Results are inconsistent, possibly due to fuel economy 

not being a major focus of many of the studies, and possibly due to sensitivity of results to modeling and 

data used. A survey by Greene (2010) finds that estimates in the literature of the value that consumers 

place on fuel economy when buying a vehicle range from negative – consumers would pay to reduce fuel 

economy – to more than 1000 times the value of fuel savings. 
3 

As discussed above, this result depends on the assumption that more fuel efficient 

vehicles that yield net consumer benefits over five years would not otherwise be offered 

on the vehicle market due to market failures on the part of vehicle manufacturers. If 

vehicles that achieve the fuel economy standards prescribed by today’s rulemaking would 

already be available, but consumers chose not to purchase them, then this rulemaking 

would not result in an increase in vehicle sales, because it does not alter how consumers 

make decisions about which vehicles to purchase. In addition, this analysis has not 

accounted for a number of factors that might affect consumer vehicle purchases, such as 

changing market conditions, changes in vehicle characteristics that might accompany 

improvements in fuel economy, or consumers considering a different “payback period” 

for their fuel economy purchases. If consumers use a shorter payback period, the sales 

impacts will be less positive, possibly negative; if consumers use a higher payback 

period, the impacts will be more positive. Also, this is an aggregate analysis; some 

individual consumers (those who drive less than estimated here) will face lower net 

benefits, while others (who drive more than estimated here) will have even greater 

savings. These complications add considerable uncertainty to our vehicle sales impact 

analysis. 

Deleted: Note