Pricing Automobile Fuel Economy: A New Hedonic Approach

This paper proposes a new approach to analyzing how automobile fuel economy is valued in the market. A distinctive feature of our approach is the use of each vehicle's miles traveled: a consumer's marginal willingness to pay (MWTP) for fuel economy is inferred with her vehicle's miles traveled. With the inferred MWTP, we apply the steps of the standard hedonic method backward and estimate each vehicle's marginal and total price of fuel economy, and consumers' discount rate for future fuel cost savings. We find that the standard hedonic method may not provide a stable and reasonable estimate of the value of fuel economy, likely due to the omitted variable bias from vehicle attributes such as safety features, interior equipment and reliability. Our method makes it possible to separate the portion of vehicle price that is attributable to fuel economy, and significantly alleviates the omitted variable bias. Applying the procedure to model year 2001 vehicles in the U.S. market, we estimate that consumers discount future fuel cost savings at the annual rate of 26-43%, that for the middle case of the discount rate of 34%, the price of a 0.1 gallon per 100 miles improvement in fuel efficiency is on average $75 (in 2000 U.S. dollars), and that for the same case, the average total price of fuel economy is $1,950. We also find that larger, less fuel efficient vehicles tend to have higher marginal and total prices of fuel economy.