Fuel Economy and Relative Prices

The essence of price theory is that relative prices affect allocation and that various shifts in supply and demand, mandated or otherwise, affect relative prices. On Wednesday, I posted on the short-term auto boom that Obama's proposed fuel-economy standards, if implemented, will cause in the next couple of years or so. There are other implications besides those I discussed.

One implication is that cars with high fuel-economy will become lower price relative to other cars. The reason: auto companies, to hit their 39 mpg standard, will price low-mileage cars artificially high to discourage "too many" sales of such cars and will price high-mileage cars artificially low to encourage more sales of those cars. What this means is that if you want to buy a Prius and you were planning to buy it in, say, 2011, you might want to wait a few years until Toyota lowers its price later in the decade to hit the target.

This point about relative prices is not new. I wrote about it in the Jan/Feb 1985 issue of Regulation. Here's the first paragraph:

Why did General Motors announce in April 1984 that because large car sales were unusually strong, it would extend small car production until October or November? Why did GM consider producing its large station wagon as a light truck instead of as a car? And what do many auto industry analysts ignore when they predict that the Big Three (GM, Ford, and Chrysler) will produce more of their small cars abroad? The answer to all three questions is CAFE-the corporate average fuel economy regulations imposed by the federal government.

Read the rest of that article for the answers. Here's the answer to the second question:

By calling a station wagon a light truck, GM could have raised its average fuel economy on both cars and light trucks.

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