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American Economic Review: Vol. 101 No. 4 (June 2011)

AER Volume. 101, Issue 4 | Previous ArticleNext Article

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Using Loopholes to Reveal the Marginal Cost of Regulation: The Case of Fuel-Economy Standards

Article Citation

Anderson, Soren T., and James M. Sallee. 2011. "Using Loopholes to Reveal the Marginal Cost of Regulation: The Case of Fuel-Economy Standards." American Economic Review, 101(4): 1375-1409.

DOI: 10.1257/aer.101.4.1375

Abstract

Estimating the cost of regulation is difficult. Firms sometimes reveal costs indirectly, however, when they exploit loopholes to avoid regulation. We apply this insight to fuel economy standards for automobiles. These standards feature a loophole that gives automakers a bonus when they equip a vehicle with flexible-fuel capacity. Profitmaximizing automakers will equate the marginal cost of compliance using the loophole, which is observable, with the unobservable costs of strategies that genuinely improve fuel economy. Based on this insight, we estimate that tightening standards by one mile per gallon would have cost automakers just $9-$27 per vehicle in recent years. (JEL L51, L62, Q48)

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Authors

Anderson, Soren T. (MI State U)
Sallee, James M. (U Chicago)

JEL Classifications

L51: Economics of Regulation
L62: Automobiles; Other Transportation Equipment
Q48: Energy: Government Policy