Consumers, Cars, and Common Sense
Skip to content
Strategy Marketing Economics May 1, 2011

Consumers, Cars, and Common Sense

The role of gas prices in American automobile purchases

Based on the research of

Meghan Busse

Christopher R. Knittel

Florian Zettelmeyer

Listening: Interview with Meghan Busse and Florian Zettelmeyer
0:00 Skip back button Play Skip forward button 34:27

When consumers visit their friendly automobile dealer, they encounter a wide variety of options: sedans, SUVs, minis, convertibles, pickups, hybrids, luxury vehicles, and others, as well as the alternatives of new or used vehicles. They also face a choice among gas guzzlers that will incur high running costs, cars with high gas mileage that will cost less over the long term, and everything in between. That choice becomes particularly critical at a time like the present, when gasoline prices show great volatility.

Add Insight
to your inbox.

Most previous analyses relating consumers’ choice of cars to gasoline prices have suggested that buyers tend to place a low value on future fuel costs relative to the selling price. But a detailed new study provides a different—and definitive—result: Rather than exhibiting mass myopia about the costs of running their cars, the study finds, the car-buying public reacts in an entirely reasonable fashion to changing prices of gasoline. “People behave consistent with the idea that they are well aware of the gas mileage when they buy,” says Florian Zettelmeyer, a professor of marketing at the Kellogg School of Management. “It’s just not true that American consumers don’t respond to gas prices.”

Busse-Zettelmeyer2010_Fig1.gifBusse-Zettelmeyer2010_Fig2.gifFigure 1. National average gasoline prices from January 1999 to July 2008 (a) and average fuel efficiency in miles per gallon of available cars by model year (b).

That finding carries a significant message for policymakers intent on finding ways to reduce emissions of carbon dioxide. “We looked at the effect of changing gasoline prices on transactions in car markets,” explains Meghan Busse, an associate professor of management and strategy who carried out the study with Zettelmeyer and Christopher Knittel, now a professor at MIT.

Specifically, Busse says, the study suggests that while any gasoline or carbon tax that affects the price of gasoline would have some impact on the carbon dioxide emissions of new vehicles, that impact would be small. In addition, any such tax would have very different effects on the markets for new and used cars, because of the different structures of those two markets. “We care about that,” she adds, “because designers of environmental policy have to think about the structure of the market into which they’re introducing that policy.”

Three Sources of Information

The researchers reached their conclusions through a thorough analysis of the effect of changes in the price of gasoline on car buyers’ choices of new and used vehicles and the resulting impact of those choices on sales prices. They based their analysis on raw material from three main sources: the Environmental Protection Agency’s data on fuel consumption for different models of automobiles, the Oil Price Information Service’s data on gasoline prices, and a market research firm’s detailed information on car sales. “We have by far the best data anyone has ever had—an enormous sample from 1998 to 2008,” Zettelmeyer says. “We also have excellent gasoline price data at the ZIP code and metropolitan-area level.”

Their information is so comprehensive, Busse adds, that it permits them to study customers’ individual choices. “We have our data from a single data source for both new and used cars, so the data are exactly comparable,” she explains.

Once the researchers had assembled and handled their vast trove of data, the conclusions became evident. “[W]e find a large change in the market shares of new cars when gasoline prices change,” they write in their paper. A $1 increase in the gasoline price leads to a 20.5 percent increase in the market share of cars in the highest quartile of fuel economy and a 23.9 percent decrease in the market share of cars in the lowest fuel-economy quartile.

New vs. Used Cars

The data also show that increases in gasoline prices have a far greater effect on prices in the used car market than on prices of new vehicles. “A $1 increase in the price of gasoline is associated with an increase of $363 in the average price of the most fuel-efficient quartile of cars relative to that of the least fuel-efficient quartile,” the paper notes. “For used cars, the estimated relative price difference is $2,839.”

Those numbers, the research team continues, provide little evidence that car buyers take a short-sighted view about future gasoline costs when they make their purchases. “Indeed,” Zettelmeyer says, “the way consumers react to gas prices is rational in the following sense: They correctly foresee the financial impact when purchasing a new car. The additional price they pay for a new car is approximately in line with the savings they expect going forward in terms of fuel cost—they’re not grossly over- or under-estimating the effect of fuel costs.”

“We calculate that a gasoline tax or a carbon tax that increased the price of gasoline by $1 would lead to a one-year decrease in U.S. emissions of carbon dioxide of 2.1 million tons from the effect on new car purchases alone.”

The finding does not surprise Busse. After all, she says, “Gas prices are among the most salient prices in the economy. So consumers have more of a sense of the costs of running their cars than of running appliances in their homes.” In fact, the result touches on a largely neglected area of research. “Little work had been done to look at how the usage costs of a durable good affect demand for that good,” Zettelmeyer says.

Finding Ways to Reduce Emissions

The study also has implications for environmental policy. On the basis of its research, the team states, “we calculate that a gasoline tax or a carbon tax that increased the price of gasoline by $1 would lead to a one-year decrease in U.S. emissions of carbon dioxide of 2.1 million tons from the effect on new car purchases alone.”

Impressive as it may seem, that amount does not indicate that policymakers can reduce automobile emissions of carbon dioxide simply by increasing gasoline taxes. “People change the cars they buy, but not all that much,” Busse explains. “The study tells us that they’re not going to abandon SUVs and pickup trucks entirely if gasoline prices go up. So consumers might be pretty resistant to policies to reduce CO2 emissions through the car avenue.” That means, she continues, that designers of environmental policy should pay attention to market structures and how the markets actually work. “We’re showing you that point for the automobile business,” she says. “Environmental policymakers should think in the same way about other sources of pollution.”

Zettelmeyer points out the message that the study provides for car buyers—and suggests a way that canny consumers can use the results to their advantage. “On average, prices of fuel-inefficient used cars fall a lot and those of fuel-efficient used cars rise a lot when gasoline prices increase,” he says. “So if you drive a lot be aware. But if you drive a little, you should buy a used fuel-inefficient vehicle when the gas price goes up.” Why? As the study shows, you will save significantly on the selling price of the gas guzzler; but because you will drive the car only rarely, the extra cost of gasoline will have only a minor effect on your purse.

Related reading on Kellogg Insight

Driving Biofuel Adoption: Brazil’s consumers offer a peek at attitudes towards alt-fuels

$1,000 Cash Back Implications for customer and dealer negotiations

And the Poor Get Poorer: The economics of higher global temperatures


Overcoming Shock at the Pump. Economist Meghan Busse says old habits likely to return once gas prices fall (audio)

Featured Faculty

Associate Professor of Strategy

Nancy L. Ertle Professor of Marketing; Faculty Director, Program on Data Analytics at Kellogg; Chair of Marketing Department

About the Writer
Peter Gwynne is a freelance writer based in Sandwich, Mass.
About the Research

Busse, Meghan R., Christopher R. Knittel, and Florian Zettelmeyer. Forthcoming. Are Consumers Myopic? Evidence from New and Used Car Purchases. American Economic Review

Read the original

Most Popular This Week
  1. Will AI Eventually Replace Doctors?
    Maybe not entirely. But the doctor–patient relationship is likely to change dramatically.
    doctors offices in small nodules
  2. 3 Tips for Reinventing Your Career After a Layoff
    It’s crucial to reassess what you want to be doing instead of jumping at the first opportunity.
    woman standing confidently
  3. What Happens to Worker Productivity after a Minimum Wage Increase?
    A pay raise boosts productivity for some—but the impact on the bottom line is more complicated.
    employees unload pallets from a truck using hand carts
  4. 6 Takeaways on Inflation and the Economy Right Now
    Are we headed into a recession? Kellogg’s Sergio Rebelo breaks down the latest trends.
    inflatable dollar sign tied down with mountains in background
  5. What Is the Purpose of a Corporation Today?
    Has anything changed in the three years since the Business Roundtable declared firms should prioritize more than shareholders?
    A city's skyscrapers interspersed with trees and rooftop gardens
  6. How to Get the Ear of Your CEO—And What to Say When You Have It
    Every interaction with the top boss is an audition for senior leadership.
    employee presents to CEO in elevator
  7. Why We Can’t All Get Away with Wearing Designer Clothes
    In certain professions, luxury goods can send the wrong signal.​
    Man wearing luxury-brand clothes walks with a cold wind behind him, chilling three people he passes.
  8. Why You Should Skip the Easy Wins and Tackle the Hard Task First
    New research shows that you and your organization lose out when you procrastinate on the difficult stuff.
    A to-do list with easy and hard tasks
  9. How Are Black–White Biracial People Perceived in Terms of Race?
    Understanding the answer—and why black and white Americans may percieve biracial people differently—is increasingly important in a multiracial society.
    How are biracial people perceived in terms of race
  10. Which Form of Government Is Best?
    Democracies may not outlast dictatorships, but they adapt better.
    Is democracy the best form of government?
  11. When Do Open Borders Make Economic Sense?
    A new study provides a window into the logic behind various immigration policies.
    How immigration affects the economy depends on taxation and worker skills.
  12. Why Do Some People Succeed after Failing, While Others Continue to Flounder?
    A new study dispels some of the mystery behind success after failure.
    Scientists build a staircase from paper
  13. How Has Marketing Changed over the Past Half-Century?
    Phil Kotler’s groundbreaking textbook came out 55 years ago. Sixteen editions later, he and coauthor Alexander Chernev discuss how big data, social media, and purpose-driven branding are moving the field forward.
    people in 1967 and 2022 react to advertising
  14. How Old Are Successful Tech Entrepreneurs?
    A definitive new study dispels the myth of the Silicon Valley wunderkind.
    successful entrepreneurs are most often middle aged
  15. How Offering a Product for Free Can Backfire
    It seems counterintuitive, but there are times customers would rather pay a small amount than get something for free.
    people in grocery store aisle choosing cheap over free option of same product.
  16. Immigrants to the U.S. Create More Jobs than They Take
    A new study finds that immigrants are far more likely to found companies—both large and small—than native-born Americans.
    Immigrant CEO welcomes new hires
  17. College Campuses Are Becoming More Diverse. But How Much Do Students from Different Backgrounds Actually Interact?
    Increasing diversity has been a key goal, “but far less attention is paid to what happens after we get people in the door.”
    College quad with students walking away from the center
  18. How Peer Pressure Can Lead Teens to Underachieve—Even in Schools Where It’s “Cool to Be Smart”
    New research offers lessons for administrators hoping to improve student performance.
    Eager student raises hand while other student hesitates.
More in Strategy