Economics of Electric Vehicles

Prof. Richard Sweeney

Overview

Broad strategy to solve climate change: Decarbonize everything
Transportation is the largest source of greenhouse gas emissions in US.
- Historically petroleum was only viable fuel for most consumers. But rapid improvements in EV tech are changing that
What policy can/should we use to encourage EV adoption?
US has adopted a subsidy first approach
- Compare that with taxes.
- Discuss optimal subsidy design.
This interacts with electricity pricing in important ways.

Background

Note: US lags behind other markets

Source:IEA

What makes someone adopt an EV?

Back to Energy Efficiency Gap Framework

Consumer chooses between two technologies:

Internal Combustion Engine (ICE) vehicle
Electric Vehicle (EV)

Total cost of ownership:

\[\text{Total Cost} = \text{Purchase Price} + \text{PV(Operating Costs)}\]

Efficient choice: Buy EV if total cost, minus any utility differences between the cars, is lower than the total cost of ICE

This gives us two margins for policy

Extensive Margin (Purchase Decision):

Should I buy an EV or an ICE?
Policy margin: ICE taxes / EV subsidies

Intensive Margin (Usage Decision):

How much do I drive?
Policy margin: Gas taxes / Electricity subsidies

Both would increase the share of EVs. Which is better?

Motivation for policy to reduce externalities

Important: Most externalities are on the intensive margin

Carbon emissions (gas > ev)
Local air pollution (gas > ev)
Congestion (same)
Road wear (ev > gas)

Economic efficiency requires taxes that internalize these marginal external costs

Tax on gasoline AND electricity (unless grid is clean)
Separate tax on driving (per mile)

First Best Policy: Pigouvian Taxes

This achieves two goals:

Correct incentive on intensive margin (how much to drive)
Correct incentive on extensive margin (which car to buy)

Key point: By fixing fuel prices, consumers optimally choose between EV and ICE based on full social costs. We don’t need additional subsidies or taxes on car purchases.

Pigouvian fuel taxes are politically difficult

So instead the US has relied on subsidizing EV purchases.
Subsidies can increase EV market share, but they can never be efficient.
- Subsidies won’t shift everyone to EVs. We still want ICE owners to drive less.
- Electricity grid still has (unpriced) emissions. EV owners will drive too much.

Still, some subsidies are better than others. How should we design these subsidies?

Subsidy targeting

Goal for subsidy design: Cost-Effectiveness

Idea: Get the most EVs per dollar of subsidy (or hit some EV target at the lowest cost)

Government budgets are constrained
Want maximum environmental benefit per dollar
Poorly designed subsidies waste money

Metric:

\[\text{Cost per additional EV} = \frac{\text{Total subsidy spending}}{\text{Additional EVs induced}}\]

What Determines Subsidy Cost?

Key parameter: Demand elasticity

\[\varepsilon = \frac{\% \Delta \text{ in quantity}}{\% \Delta \text{ in price}}\]

Demand elasticity determines:

How many additional EVs the subsidy induces
How many people get subsidies who would have bought anyway

Marginal vs. Inframarginal Costs

Every subsidy hits two types of consumers:

Marginal effect (what we want):

Induces NEW purchases
People buy BECAUSE of the subsidy
These are “additional” EVs
Creates social benefit

Inframarginal effect (waste):

Subsidizes EXISTING demand
People who would have bought anyway
No change in behavior
Pure transfer, no social benefit

Problem: We can’t tell who is marginal vs. inframarginal – so everyone who buys an EV gets the subsidy

Visualizing the Problem

Defining Additionality

Additionality = Fraction of subsidized EVs that are marginal to the subsidy

\[\text{Additionality} = \frac{Q_s - Q_0}{Q_s} \approx \frac{\varepsilon \cdot s/P}{1 + \varepsilon \cdot s/P}\]

Demand elasticity (ε)
Size of subsidy (s)
Base price (P)

Higher |ε| → higher additionality → more cost-effective

Which market segments to target?

Case 1: Tesla Purchases in California

Assumptions:

Average Tesla price: ~$80,000
Combined subsidy: $10,000 (12.5% of price)
% increase in quantity demanded = (|elasticity|) * (subsidy/price)
cost per car = (subsidy * Qs)/ (Qs - Q0)

Elasticity	Additionality	Cost per Additional EV ($000)
-1.5 (low)	16%	$63.3
-2.5 (mid)	24%	$42
-3.5 (high)	30%	$32.9

Even with a high elasticity, 70% of Tesla subsidies are wasted on inframarginal buyers, and the cost per additional EV is $33k!

Case 2: Non-Tesla EVs in California

Assumptions:

Average non-Tesla EV price: ~$35,000
Combined subsidy: $10,000 (29% of price)

Elasticity	Additionality	Cost per Additional EV ($000)
-1.5 (low)	30%	$33.3
-2.5 (mid)	42%	$24
-3.5 (high)	50%	$20

Lower-priced vehicles have better cost-effectiveness, but total cost per additional EV close to the price of a car itself!

Policy Implication: Who to Target?

To maximize cost-effectiveness, target:

1. Lower-priced vehicles

Higher subsidy as % of price
More elastic demand

2. More price-sensitive consumers

Lower-income households
More responsive to subsidies

To date EV subsidies have not been equiable

Average EV Credit per Tax Return, By Income Level

Source: Davis

Fuel Costs

Reminder: Up front costs are only part of the story

Operating costs matter because:

They affect the extensive margin (which car to buy)
They affect the intensive margin (how much to drive)

These vary meaningfully across space and time (but differently for EVs vs. ICEs)

Gasoline prices vary a lot over time

Difference across states at any time is relatively small

Electricity prices vary a lot across space

The Increasing Block Pricing Problem

Many California utilities use Increasing Block Pricing (IBP):

Tier 1: Low rate (e.g., $0.15/kWh)
Tier 2: Medium rate (e.g., $0.25/kWh)
Tier 3: High rate (e.g., $0.40/kWh)

Problem for EVs:

EV charging pushes you into higher tiers
Marginal cost of EV charging can be very high
Reduces private incentive to buy EV

Special EV Rates: Good or Bad?

Many utilities offer special EV rates:

Cheaper electricity for EV charging
Often time-of-use (TOU) rates
Incentivizes off-peak charging

Are these efficient?

❌ No! Electricity price should equal social marginal cost regardless of end-use

Problems:

Creates distortion between EV charging and other uses

Better: Price all electricity at SMC, then add Pigouvian tax/subsidy

Reminder: Electricity prices both too high and too low

Environmental Benefits

Spatial Variation in Optimal Policy

Environmental benefits vary by location:

High EV benefit:
- Clean electricity grids (CA, WA, NY)
- Dense, polluted urban areas
- Places where people would otherwise drive gas guzzlers
Low/negative EV benefit:
- Coal-heavy grids (Midwest)
- Less urban density
- Places where people would otherwise drive efficient gas cars

Key point: One-size-fits-all federal subsidy is inefficient

How much are EVs driven?

Many US households have two cars:
- One more efficient / cheaper to drive
- One used for longer trips or specialized purposes
For wealthier households:
- EV may be the second or third car
Key questions:
- How many ICE vehicle-miles traveled (VMT) are actually replaced by EV miles?
- What if EVs have higher embedded emissions from materials?

Davis (2018): EVs driven much less

Davis (2018) finds that EVs are driven much less on average than comparable ICE vehicles.
If EVs are driven fewer miles:
- The per-mile benefit of lower operating emissions must be weighed against:
  - High embedded emissions (especially batteries)
This can undermine environmental gains if EVs are underutilized.

Charging

Why is EV adoption so low?

Main barrier is often range anxiety

How long is the typical trip?

Why is range such a big issue for car buyers then?

Charing is also much slower

AC Level 1 (120V)
- About 2–5 miles of driving per hour of charging.
AC Level 2 (240V)
- About 10–20 miles of driving per hour of charging.
- Costs about $2,000 to buy and install.
DC Fast Charging
- About 50–70 miles per 20 minutes of charging.
Tesla has a proprietary port and Supercharger system

Many dwellings lack dedicated parking

Not just an income issue

Fast chargers have been growing rapidly.

Still small relative to existing gas station network

Subsidize chargers instead of cars?

What are some pros and cons of this?

Would it be more cost-effective?

Springel (2018) studies this in Norway

Chargers more cost-effective at high levels

Another problems: Not all chargers are compatible.

This standard problem is common in imperfectly competitive markets

Part of why Tesla dominated this market early

Should we mandate compatibility?

Li (2019) finds:

Under compatibility:
- Firms reduce investment in charging stations (weaker network differentiation).
But:
- The EV market size expands due to better network coverage.
Net effect:
- Policy is welfare-improving, even accounting for reduced private investment.

EV Wrap-up

The social optimum amount of EV’s is surely higher than current levels.
- Petroleum externalities are largers than electricity externalities (in most places)
- We need to decarbonize transportation to meet climate goals.
The optimal policy would be to put Pigouvian taxes on both gasoline and electricity.
- This would hit on both the extensive margins (what cars people buy) and intensive margina (how much they drive). Make sure you understand this point.
Instead policymakers have opted to subsidize the EV transition.
This will be expensive, but some subsidies are more cost-effective than others.
- Targeting lower-priced vehicles and more price-sensitive consumers improves cost-effectiveness.
- Targetting subsidies geographically to areas with cleaner grids and higher pollution damages would also better target the environmental benefits.
Reducing electricity costs where they are above social marginal cost is also cheaper than subsidizing EV purchases.
For many consumers, the main barriers to EV adoption are range anxiety and charging infrastructure.
- Subsidizing chargers instead of cars may be more cost-effective in some locations.