Is demand for polluting goods manageable? An econometric study of car ownership and use in Mexico

Our motivation for estimating a demand system for gasoline and cars is its strategic relevance to policy objectives such as pollution control: if demand is responsive to pricing, demand reductions for polluting goods will provide an important share of the pollution reductions; otherwise, cleaner technologies will have to do most of the job. We estimate a model of gasoline demand and car ownership in Mexico, using a panel of annual observations by state. Key features that we introduce include instrumental variables on differenced data and the treatment of possible dynamics, measurement errors in the data, and unobserved individual state characteristics. We use tests of serial correlation in the residuals to model the dynamics properly. The resulting demand system is quite responsive to pricing even in the short term (-0.6 for the own-price elasticity of gasoline), but we emphasize a medium-to long-term perspective of 5-10 years as most relevant for policy. Five-to ten-year elasticity estimates are in the range of -1.25 to -1.13. Applying these elasticity estimates to data on pollution control options for the vehicle fleet in Mexico City, the costs of reaching a target for pollution reductions would be 45% more expensive if one were not willing to use a demand management instrument such a gasoline tax in the control program. (C) 1997 Elsevier Science B.V.