Saving Gasoline

President Bush has proposed raising the CAFE standards (Corporate Average Fuel Economy. The CAFE standards require automakers to produce a fleet of cars that meet a minimum number of miles per gallon (27.5 for cars 20.7 for trucks and SUVs.) CAFE standards do not require all vehicles to meet this level, a car maker could sell a car that gets 37.5 mpg and one that gets 17.5 mpg and still meet the standard since it is an average for their fleet. There are also provisons for earning credits for exceeding the standards or taxes for not meeting the standards which being gov't regulations are incomprehensible to life as we know it.

The purpose of the CAFE standards is to reduce the demand for gasoline. If cars get better gas mileage, then consumption of gasoline will fall and hence the demand for crude oil will also fall. Benefits of lower crude oil demand are less dependence on foreign sources, and since less fuel is consumed, cleaner air.

The problem is that it is not at all clear that any of these benefits will result. Consumption of gasoline will probably decline but that is not certain. Cars that get higher mileage are less costly to drive. Since the cost of driving a mile is lower, we can expect that people will drive more miles. Since consumers are driving more they will use more gasoline, at the very least offseting some of the reduction in demand due to higher mileage.

If the demand for gasoline and thereby oil is reduced then we would expect the price to fall. Quantity demanded for other uses, like home heating, will rise due to the lower price. Quantity supplied will also fall due to the lower price. Where will quantity supplied fall? Those producers that have the highest cost of production will reduce output first. Most of these high cost producers are domestic so domestic quantity supply will fall relatively more. Will imports drop? Maybe or maybe not.

So CAFE standards might or might not lower consumption of gasoline. If gasoline consumption does fall it might or might not lower consumption of imported oil.

If we really want to reduce consumption of gasoline, raise the gasoline tax. Higher prices will reduce the quantity demanded of gasoline. If we really want to reduce quantity demanded of foreign oil, put a tax on imports. Higher prices will reduce the consumption of gasoline. People will drive less and over time buy higher mileage vehicles.