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AALTO UNIVERSITY SCHOOL OF BUSINESS Master’s Thesis, Economics 17.12.2012 Emma Saarinen

ABSTRACT:

Consumer valuations of fuel economy - A study of the Finnish automobile market

The diffusion of energy-efficient technologies can play an integral role in mitigating the detrimental effects of energy use to the environment. However, a host of studies have concluded that the market for conservation technology investments does not operate efficiently and thus does not guarantee an optimal level of investment in energy-efficient technologies. The aim of this study is to discuss whether suboptimal consumer choices contribute to the seemingly slow diffusion of conservation technologies such as automobile fuel economy. Indeed, we aim to find out whether consumers are giving an appropriate amount of weight on future fuel costs when purchasing vehicles - an underweight on operating costs would effectively slow down the diffusion of fuel-efficient vehicles. Furthermore, if consumers do not fully account for the future gasoline costs when purchasing a vehicle, gasoline taxes will fail to secure an optimal level of fleet fuel economy and more paternalistic policies are warranted. This study consists of a review of the earlier literature on consumer fuel economy choices and discrete choice models of the vehicle market as well as an empirical study of the Finnish vehicle market. In the empirical part of this study we will employ discrete choice methods initially developed by Berry (1994) and Berry et al. (1995) and follow quite closely a nested logit specification presented by Allcott et al. (2011) to disentangle consumer preferences for fuel economy. Our dataset contains new vehicle registrations as well as vehicle characteristics and prices for 2005-2011 in Finland. The existing literature does not offer any clear consensus as to whether consumers are making optimal price-fuel cost trade-offs. Similar to Allcott et al. (2011), our study suggests that consumers are underweighting future gasoline costs compared to the upfront vehicle price.

KEYWORDS: automobile market, consumer choice, fuel economy, discrete choice models, price endogeneity, nested logit, energy paradox, conservation technology