Dr. Christopher Knittel, Associate Professor of Economics, Chancellor's Fellow, UC Davis
The dramatic increase in gasoline prices from close to $1 in 1999 to $4 during the peak in 2008 has made it much more expensive for consumers to operate an automobile. In this paper we investigate whether consumers have adjusted to gasoline price changes by altering what automobiles they purchase and what prices they pay. We consider new and used car markets. We find that a $1 increase in gasoline price changes the market shares of the least and most fuel efficient quartiles of new cars by +25% and -22%, respectively. In contrast, the same gasoline price increase changes the market shares of the least and most fuel efficient quartiles of used cars by only +4% and -7%, respectively. We find that changes in gasoline prices also change the relative prices of cars in the most fuel efficient quartile and cars in the least fuel efficient quartile: for new cars the relative price increase for fuel efficient cars is $382 for a $1 increase in gas prices; for used cars it is $2723. Hence the adjustment of equilibrium market shares and prices in response to changes in usage cost varies dramatically between new and used markets. In the new car market, the adjustment is primarily in market shares, while in the used car market, the adjustment is primarily in prices. We argue that the difference in how gasoline cost affect new and used automobile markets can be entirely explained by differences in the supply conditions of new and used cars.