Sunday, March 25, 2012

Obama, CAFE Standards, and Economic Illiteracy…

On the campaign trial, aware of the danger to his Presidency of $4/gallon gasoline, President Obama is telling the bumpkins that in a few years, due to his efforts, mandatory fuel economy standards will have new cars providing us with 55 mi/gallon efficiency.
One wonders why he didn’t simply mandate 100 mi/gallon…
Ignore for the moment the extensive research that rising CAFE standards mean lighter cars, which in turn mean greater risk of injury and death in car crashes. Tanks are safe, but not fuel efficient. 
Instead focus on how the President sells this to the rubes: “55 miles/gal means that over the life-time of the car, you’ll save $8,000! I bet there are some people here that would like an additional $8000 in their pockets! [Applause] Am I right? [Applause.]” 
I mention here that the above paragraph is me in a Michael Daisey moment. Michael Daisey, you’ll recall, is the monologist who lied in his one man show, and lied on public radio’s This American Life, about conditions in the Chinese factories Apple uses to make their iPads, lies he claims capture the dramatic essence of his “The Agony and Ecstasy of Steve Jobs.” So I should admit out front, without waiting for the Ira Glass interview, that what I affirm the President as saying in quotes above may not be exact--I was driving when I heard the President say it on NPR’s All Things Considered this afternoon--but I think it largely captures the dramatic essence of his campaign hokum. It certainly gets a lot closer than Daisey did, and is a mere paraphrase, not a lie. Call it the Agony and Ecstasy of Barack Obama…
Call it as well the economic illiteracy of Barack Obama. He seems to think that if a car now sells at $X, and in the future an otherwise identical car will save you $8000 in gas over its lifetime, that car will still sell for $X. That is, he assumes you, the consumer, get the entire benefit of the gas savings.
Yet he has foisted new light bulbs on us that he claims are not only environmentally safer but WILL LAST LONGER. “Over the course of the light bulb’s lifetime, you’ll save…” Did he not notice they also became more expensive? That’s not ONLY because they are more expensive to make. Any businessman knows you can’t just blithely pass on any increased costs to your customers willy-nilly. One reason the producers can charge more here is that the light bulbs last longer. That is, the producer got a component of the savings associated with the light bulb’s longer life. Does it surprise anyone that if one new light bulb lasts as long as two old ones, the new light bulb price about doubles?
What about new cars with higher CAFE standards? Economists talk about a product’s “elasticity.” This is a measure of the effect a rise or fall in price has on the quantity of a good demanded. 
We know demand curves slope down; that is, that the higher the price, the less is demanded. Elasticity measures the steepness of that slope. Nearly vertical curves--where large changes in price have little effect on quantity demanded--are INelastic. Nearly horizontal curves--where small changes in price have large effects on quantity demanded--are very elastic.
What does this have to do with who gets the $8000 savings from better gas mileage? It turns out--economists can prove this--the more inelastic the demand curve, the greater the share of the benefit goes to the producer, as seen in increased car prices (paid up front); the more elastic, the greater the share of the benefit goes to the consumer (in lower gas charges, a benefit accrued slowly over several years.)
So are cars, and their demand curves, relatively elastic or inelastic? Economists have certain heuristics as to what goods and services are more or less elastic:
  • All else being equal, durable goods tend to have inelastic demand curves. Cars are durable goods.
  • All else being equal, short-run responses to changes tend to be inelastic. Long-run effects, giving people time to plan and react, tend to be more elastic. So rules that take place on a particular model year tend at least initially to be inelastic.
  • To the extent there are close substitutes, demand curves for goods are elastic. If, for example, the CAFE standards applied to Chevys but not GM cars, the quantity demanded for Chevys would be elastic. You could easily substitute a GM. To the extent that all cars and trucks are held to the same CAFE standards, the changes in quantity demanded will be inelastic.
Therefore, all indications point to the car producers generating most of the $8000 from improved gas mileage, which is to say the cars will likely be about $8000 more expensive. Of course, getting back to Kasman’s research that car companies have to trade off car safety for improved fuel standards, the consumer will be taking all the increased risk of injury in car accidents.
So: Consumers take all the increased risk and little of the increased savings associated with higher CAFE standards. And this is what the President considers a big winning argument for him on the campaign trail. And given the average voters’ knowledge of economics is as weak as the President’s, he may just be right...
NOTA BENE: If you’re in the audience when President Obama makes this point, DO NOT ask, “But won’t the car companies just charge $8000 more for the cars?” This will immediately lead to price control legislation...


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