Figures 6-3 – 6-7 summarize the estimated results from the imposition of a single federal fuel consumption standard. The reductions are measured relative to an un- constrained case. A federal fuel consumption standard of 2.7 gallons / 100 miles in 2025 would not bind under the assumptions outlined above, so this case represents the modeled free-market outcome. Moving to the left in each figure, the standard becomes tighter, and prices increase, sales and profits decrease, acceleration times deteriorate, and more advanced technologies are adopted.
Each one of Figures 6-8 – 6-11 summarize the firm profitability and leakage impli- cations of the (non-cooperative) Nash equilibria as a function of the fuel consumption standard in the adopting states and the cost to firms of developing a separate variant of their model for adopting and non-adopting states. The four figures correspond to different combinations of loose and tight federal standards and larger and smaller market shares for the adopting states.
Let us first consider Figure 6-8. The upper panel summarizes the non-cooperative leakage outcomes when there is a loose federal standard (2.5 gal/100 miles, 40 mpg) in force, and the adopting states represent 20% of the total market. Start by considering
Figure 6-3: Price increases are predicted as federal fuel consumption standard is tightened.
If the adopting states tighten their standard to 2.3 gal / 100 miles, however, then the outcome depends on the cost to firms of creating separate product variants. If a special variant for the adopting states can be developed for $100 million, then the Nash equilibrium has each firm creating two variants. In this case, the national average fuel consumption stays at 2.5 gal / 100 miles, indicating that the expected fuel savings in the adopting states have leaked out to the non-adopting states. However, look now at panel 2. In the Nash equilibrium, the profits per firm are actually lower than they would be if all of the firms simply built to the tighter standard nationwide. In the absence of cooperation, however, each firm has an incentive to produce two variants. This is individually rational for each firm but collectively
Figure 6-4: Sales are predicted to fall as federal fuel consumption standard is tight- ened.
suboptimal for the industry as a whole. Thus, the automobile producers in this case would have an incentive to lobby the federal government to adopt the tighter 2.3 gallon / 100 mile standard nationwide. This standardization would remove the incentive for individual firms to create separate variants for adopting and non-adopting states, and increases profitability for all firms. This would also mitigate the predicted leakage effect, through what I earlier termed de jure homogeneity.
The results are different, however, if the costs of creating a separate variant are higher. If the cost of creating an additional variant is $200 million or more, then
Figure 6-5: Reduction in profits per firm under a single federal fuel consumption standard.
this variant in all states. In this case, the adopting state standard would be followed nationwide, no leakage would occur, and we have an example of de facto homogeneity. Let us next consider the possible outcomes if the adopting states adopt a tighter standard: 2.1 gallons / 100 miles. Now, if the cost of a second variant is $100 million, then the most profitable course of action for the firms — both individually and collectively — is to split their models into two variants each. Here we have leakage, and no incentive for the firms to support harmonization of state and federal standards. This is the heterogeneous outcome. However, if the cost of creating two variants is higher — $200–300 million — then it is individually rational but collectively suboptimal for each firm to create two variants of its model. In this case the firms
Figure 6-6: Acceleration times deteriorate under a federal fuel consumption standard as firms trade off acceleration performance for lower fuel consumption.
again have an incentive to support federal adoption of the tighter standard, as it is more profitable to build a single variant to the tighter standard, as long as everyone else does so as well. Once again, the incentives are aligned for the creation of de jure homogeneity.
Figure 6-9 shows similar results, when the adopting states are a larger share (40%) of the national market. Several differences are notable, compared with the prior case in which adopting states represent only 20% of the market. First, for an adopting state standard of 2.3 gal / 100 miles, there is no incentive for firms to create a second
Figure 6-7: A tighter federal fuel consumption standard is predicted to increase the application of advanced efficiency technologies.
so we end up with de facto homogeneity regardless of the cost of developing a second variant (within the range of costs investigated). Second, even when leakage occurs, as when the adopting states adopted a standard of 2.1 gal / 100 miles, the national average fuel consumption does not return all the way to the federal standard of 2.5 gal / 100 miles, indicating that leakage is only partial. Finally, the results indicate that if the adopting states tightened their standard to 1.9 gal / 100 miles, the firms would have an incentive to lobby for national adoption of the tighter standard (de jure homogeneity) if the cost of developing a second variant were $200 million or more. However, if it were less than $200 million, they would be better off in the non-cooperative equilibrium, selling two variants each.