If the transport sector is to make deep cuts to its carbon emissions, it is necessary to reduce the carbon-intensity of travel. Reducing travel itself, at some times and places, is sometimes justified but it is extremely unlikely that under expected global economic development patterns overall demand will decline. This holds true even if there is saturation in some markets and demand management policies are widely adopted. Technological change is therefore crucial. The emerging view is that the focus for decarbonising transport should be first to improve the fuel efficiency of conventional engines and then gradually introduce alternative technologies.

In cases where the first-best carbon tax and a reasonable second-best gasoline tax are unavailable, this paper demonstrates how alternative combinations of instruments can form economically-sound, environmentally-motivated policies for substantial reductions in vehicle carbon emissions. In order to implement alternative approaches successfully, our point is that policymakers may need to take a holistic approach when designing policy. This holistic approach would recognise that policies to reduce carbon emissions must be politically feasible, and that all sectors of the economy generate carbon emissions. A holistic approach would not focus just on one method of abatement, like encouraging low-carbon vehicle technologies, but instead on the efficient balance between all different abatement methods.

Passenger vehicles are a major source of greenhouse gas emissions and prodigious consumers of petroleum, making their fuel economy an important focus of energy policy. Whether or not the market for fuel economy functions efficiently has important implications for both the type and intensity of energy and environmental policies for motor vehicles. There are undoubtedly imperfections in the market for fuel economy but their consequences are difficult to quantify. The evidence from econometric studies, mostly from the US, is reviewed and shown to vary widely, providing evidence for both significant under- and over-valuation and everything in between. Market research is scarce, but indicates that the rational economic model, in general, does not appear to be used by consumers when comparing the fuel economy of new vehicles. Some recent studies have stressed the role of uncertainty and risk or loss aversion in consumers’ decision-making. Uncertainty plus loss aversion appears to be a reasonable theoretical model of consumers’ evaluation of fuel economy, with profound implications for manufacturers’ technology and design decisions. The theory implies that markets will substantially undervalue fuel economy relative to its expected present value. It also has potentially important implications for the welfare analysis of alternative policy instruments.

For several years now, numerous states and regions have developed policies to reduce CO2 emissions from the transport sector. More precisely, CO2 emissions reductions from cars were in most cases the first target of these policies. Over the last two years, policymakers have tightened the rules currently in force and developed new regulations, in line with public concern about climate change and the growing importance of energy policies.

This report organises and discusses empirical estimates of the effects of fuel prices and fuel emissions standards on consumer and firm behaviour. Model-free estimates are only briefly touched upon. The focus is on results based on explicit models, taken mostly from the industrial organisation literature. First, studies are reviewed that identify the willingness to pay for fuel efficiency using static and dynamic models of vehicle demand. Next, the fact that firms will adjust their product portfolios and the characteristics of the vehicles they offer is taken explicitly into account. These decisions will have an impact on the choice set from which consumer demand is estimated and on the trade-off that consumers face between fuel efficiency and other desirable characteristics. Finally, models are discussed where firms choose to invest in innovations to achieve fuel efficiency gains without sacrificing characteristics.