Monday, September 1, 2008

The Metrics of High Gas Prices

In the United States, gas prices hit all-time highs this year, even in inflation-adjusted dollars. This new reality has motivated some rethinking about metrics related to cars, gas, and money.

Total Cost of Ownership for Cars

Total Cost of Ownership (TCO) is a metric that includes not only the purchase price of a car but also the costs to run and maintain the car over time. While a business would likely use TCO to evaluate buying a fleet of cars, relatively few consumers use it when buying their own cars.

However, new-car buyers are increasingly doing a rough form of TCO as they abandon gas-guzzling SUVs and trucks in favor of fuel-efficient cars. Moreover, according to this New York Times article, many consumers are using their future savings at the pump to load up on options like leather seats and fancy car stereos.

In this new math for the auto industry, gas mileage often trumps sticker price for consumers.

“Affordability is not so much the issue as fuel economy,” said George Pipas, Ford’s chief sales analyst. “Just because you want more fuel efficiency doesn’t mean you don’t want a moonroof or leather interior.”

Gallons Per Mile

Earlier this summer, a pair of Duke University professors published research that suggests people often misinterpret the “miles per gallon” metric when comparing different cars. For example, which of the following saves the most gas?

(a) Replacing a 20-MPG car with a 40-MPG car

(b) Replacing a 10-MPG car with a 20-MPG car

(c) The previous two choices will have an equivalent effect

Many people don’t realize the answer is (b). However, if you flip the metric to be gallons per mile—or better, gallons per 10,000 miles—things clarify. (Gallons per 10,000 miles just means the number of gallons of gas necessary to drive 10,000 miles.)

Per this spreadsheet...

...a 10-MPG gas guzzler requires 0.10 gallons to go a mile; that is 1,000 gallons for 10,000 miles. In comparison, the 20-MPG normal car takes 500 gallons to go 10,000 miles. And the 40-MPG efficient car takes 250 gallons to go 10,000 miles. So switching from the gas guzzler to the normal car saves double the gas as switching from the normal car to the fuel-efficient car. At $4 per gallon, that’s a $2,000 versus $1,000 savings.

This result is worth considering in light of government policies that simply promote ownership of fuel-efficient cars. Such policies might instead want to base the subsidy on the fuel-inefficiency of the owner’s previous car, thereby creating greater incentives to get the worst gas guzzlers off the road.

We Feel It Because We See It

Behavioral economist Dan Ariely, author of Predictably Irrational, had a recent piece about why there’s so much angst about gas prices. He argues that we care more about gas prices than the prices of other necessities because when we buy gas, the cost adds up right before our eyes.

Looking back at my family’s expenses over the past few years, I see big increases in our health care costs and in how much we pay for food. The rise in what we spend on gas is not nearly as extreme as our increases in categories like electricity and telephone. So why does the amount we spend on gasoline feel so enormous? I think it is because of the way we buy gas.

For the several minutes that I stand at the pump, all I do is stare at the growing total on the meter — there is nothing else to do. And I have time to remember how much it cost a year ago, two years ago and even six years ago.

Yet I have no such memory about the prices of items in any other category. I have no idea how much milk was six years ago, how much bread was three years ago or how much yogurt was a week ago. But I suspect that if I stood next to the yogurt case in the supermarket for five minutes every week with nothing to do but stare at the price, I would also know how much it has gone up — and I might become outraged when yogurt passed the $2 mark.

I like the spirit of the example, but I don’t know anyone who buys $50 worth of yogurt per week or whose livelihood relies on eating yogurt. In contrast, large numbers of people have those situations with gas.

I would have rather seen Ariely use health care as the example. At various points in people’s lives, it’s an absolute necessity, yet few people understand exactly how much they pay (through some combination of direct, employer, and insurer payments) or how that amount has changed over time.

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