Monday, May 6, 2019

Fuel Efficiency Regulations and Automobile Mergers

This post shows that regulations requiring an average fuel efficiency for a fleet of cars sold by a car company can create an incentive for two care companies to merge in order to avoid paying a fine for not meeting the fuel efficiency standard.

 Question  Fuel efficiency numbers for the two automobiles and the quantity purchased for each vehicle are presented below. 

Auto Sales and Fuel Efficiency for
a Hypothetical Market
# of Automobiles

A law requires that the fleet harmonic average for all vehicles sold in a model year be 27.5 mpg or greater.

Firms that fail to meet this average must pay a fine.

The fine is $5.50 for each 0.1mpg below 27.5 multiplied by the number of vehicles sold.

What is the fuel efficiency fine for a firm that sells 1500 cars that get 20 miles per gallon?

What is the fuel efficiency fine for a firm that sells 1000 cars that get 38 miles per gallon?

What is the fuel efficiency fine for a firm that sell 2500 cars – 1500 getting 20 mpg and 1000 getting 38 mpg?

Discuss the likely impact of the fuel efficiency regulation on market structure in the automobile industry?

Calculations:   The fuel efficiency average for the firm with only a 20 mpg vehicle is 20.    The firm is 7.5 percentage points below the legal limit.  Since 7.5/ 0.1 is 75 the fine per car is $5.50 x 75 or $ 412.50.    The total fine for this firm is 1500 x $ 412.50 or $618,750.

The fuel efficiency average for the car that only makes the 38 mpg car is 38 mpg.   This fleet average for this firm exceeds the limit that would trigger a fine.   This firm is not fined.

 The fleet average for the firm that sells 1500 cars that get 20 mpg and 1000 cars that get 38 mpg is

AVG = (1500 + 1000) / ((1/20) + (1/38))

or 24.6753

Harmonic Average Calculation
# of Automobiles Sold

Note (27-24.6753)/0.1 is 28.2468.

The fine in this case is 28.2468 x $5.50 x 2500 or  $388,393.


Under this scheme, it is possible for a firm planning to build large gas guzzlers to avoid the fuel efficiency fine by simply purchasing a company that also builds small cars.   (Extra credit: How many 38 mpg cars would a company that wants to sell 1500 20 mpg cars have to sell in order to avoid the fuel efficiency fine?)

The old fuel efficiency law gave a substantial advantage to multi-line firms – Toyota, Honda, GM and Ford – over smaller firms like Mercedes and BMW.   The only firms that have paid fuel efficiency fines in the United States are smaller European firms with narrower lines.

The merger between Mercedes and Chrysler temporarily allowed Mercedes to reduce its fines.

The fuel efficiency regulations in the United States have changed.   The required fuel efficiency now varies for cars of different size.   It is now possible to build a fuel-efficient large car and avoid fines.   This change in the fuel efficiency law is probably one of the factors that allowed Mercedes and Chrysler to break up.

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