This is “Policy Issues”, section 16.4 from the book Theory and Applications of Microeconomics (v. 1.0). For details on it (including licensing), click here.

For more information on the source of this book, or why it is available for free, please see the project's home page. You can browse or download additional books there. You may also download a PDF copy of this book (30 MB) or just this chapter (2 MB), suitable for printing or most e-readers, or a .zip file containing this book's HTML files (for use in a web browser offline).

Has this book helped you? Consider passing it on:
Creative Commons supports free culture from music to education. Their licenses helped make this book available to you. helps people like you help teachers fund their classroom projects, from art supplies to books to calculators.

16.4 Policy Issues

Learning Objectives

  1. What are some policies to control the emissions from cars?
  2. How do trade policy and international investment affect the car market?
  3. What is the problem of congestion, and what can governments do about it?

There are many ways in which government policies impinge on automobiles. Here we highlight a few such issues.

Environmental and Resource Concerns

In Chapter 2 "Microeconomics in Action", we showed a photograph of smog in Mexico City. At the same time that cars have transformed the economic world, they have also transformed our natural environment. The exhaust from cars contributes to air pollution, which is hazardous to health. Car exhausts are a source of greenhouse gas emissions and thus contribute to climate change.

Pollution from cars is a classic example of an externality. (We discussed externalities in detail in Chapter 13 "Cleaning Up the Air and Using Up the Oil".) An individual’s decision to purchase and drive a car does not take into account the effects on third parties. In this case, some of the affected third parties are those in the immediate vicinity who suffer from a reduction in air quality. To the extent that emissions contribute to climate change, however, the third parties potentially include everyone in the world.

Toolkit: Section 17.19 "Externalities and Public Goods"

You can review the definition and use of externalities in the toolkit.

Governments in the United States and elsewhere have enacted various policies that are motivated, at least in part, by the desire to take into account such environmental externalities and resource use. First, there are taxes on gasoline. These are relatively low in the United States but are much higher in Europe. Second, there are technological restrictions, such as the requirement that automobiles be fitted with catalytic converters and designed to run on unleaded fuel. In the United States, the government has taken action to improve the fuel consumption of cars produced within US borders. These are called Corporate Average Fuel Economy (CAFE) standards.CAFE standards are described in detail at the National Highway Traffic Safety Administration site, “CAFE Overview—Frequently Asked Questions,” accessed March 14, 2011, You can notice two things from this term: (1) the restrictions are in terms of fuel economy (miles per gallon), and (2) the restriction does not apply to individual automobiles but rather to the set of cars sold by a corporation. For example, the standard is applied to the entire set of models produced by General Motors (GM), not model by model, so GM makes some cars that are below the standard and others that are above. Corporations that do not meet the standard are fined.

The CAFE standard comes from legislation passed in 1975 in response to the embargo by oil-producing countries in 1973. The initial motivation was to reduce energy consumption and, in part, make the United States less dependent on imported oil. The arguments today for these standards also include the effect of car emissions on global warming.

Trade and Investment Policies

A second government policy that has had a huge impact on the automobile industry is the opening of the world economy to trade and international investment. The current automobile market is no longer just a US market. The United States is part of the world market. US producers interact with the rest of the world by

  • selling cars in many countries,
  • buying parts from suppliers throughout the world,
  • producing in many countries,
  • being financed by debt and equity held in foreign countries.

Meanwhile, US citizens

  • own cars produced in other countries and imported into the United States,
  • consume imported oil,
  • work for foreign companies that produce cars in the United States,
  • work at car production facilities in other countries.

For example, let us look at Ford Motor Company. In 2007, Ford had 95 plants worldwide and employed about 246,000 people. The Ford operations in North America (United States, Canada, and Mexico) had 94,000 employees. In other words, 62 percent of the workforce was employed outside North America. There are Ford plants all over the world. Ford’s 2009 annual report tells us that Ford sold 4.82 million cars in 2009. Of these, 2.0 million were sold in North America, 1.6 million in Europe, and the remainder in South America and Asia.Ford Motor Company, “Annual Reports,” accessed March 14, 2011,

This international structure permits diversification. Ford produces and sells cars in China, South America, and elsewhere around the world. If you browse Ford’s global activities,Ford Motor Company, “About Ford: Global Vehicles Sites,” accessed March 14, 2011, you will get a sense of its worldwide sales and production operations.Ford Motor Company, “About Ford: Global Operations,” accessed March 14, 2011,

Each producer of cars has its own story of expansion across international borders, both through trade and through production. Honda began operations in the United States by creating a motorcycle sales division in the late 1950s. This eventually led to the production of motorcycles in the United States in 1978 and ultimately the production and sales of Honda cars in the United States.Honda Worldwide, “Establishing American Honda Motor Co. (1959),” accessed March 14, 2011,

None of this would be possible without governments permitting the movement of goods and capital.

The first trade policy action directly impacting car production was the Canadian-US Automotive Products Trade Agreement of 1965. The goal of this agreement was to create an integrated market for cars between the United States and Canada by eliminating tariffs. Concerns that US companies would sell but not produce cars in Canada were met by some restrictions on production, including requirements that cars built in Canada had to have a certain domestic content.

The second trade policy action was called the North American Free Trade Agreement (NAFTA).US Department of Agriculture, Foreign Agricultural Service, “North American Free Trade Agreement (NAFTA),” accessed March 14, 2011, NAFTA was a controversial trade agreement. One of the big issues was whether the reduction in trade barriers would lead to job destruction in the United States. (We discussed this in Chapter 8 "Growing Jobs".) A 2001 study looking back at the effects of NAFTA directly on the production of cars did not find large effects at all.

Most fears about the ill effects of NAFTA on the U.S. auto industry, whether in term of employment, wages, or investment, have been proven wrong. The U.S. auto industry did experience rationalization of production and hence job displacements. But overall, NAFTA appears to have helped the U.S. auto sector (U.S. Trade Representative, 1997). Employment in the American automotive industry grew by 14.1 percent overall, with an increase of 16.1 percent in the auto parts sector and 10.1 percent in the motor vehicle assembly sector from 1994 to 1996. Hourly earnings for production workers in the U.S. automotive sector grew by 5.6 percent between 1993 and 1996. The Big Three U.S. automobile manufacturers invested $39.1 billion from 1993 to 1996 in new manufacturing plants and equipment in the United States, while investing only $3 billion in Mexico over the same period.Mary E. Burfisher, Sherman Robinson, and Karen Thierfelder, “The Impact of NAFTA on the United States,” Journal of Economic Perspectives 15 (Winter 2001): 125–144.

These statistics, of course, refer to what actually happened in the auto sector over this time period. What would have happened had NAFTA not been implemented requires a more sophisticated analysis.


If you travel to Mexico City or Manchester, Beijing or Buenos Aires, Jakarta or Johannesburg, Los Angeles or Lagos, you will see that these cities all have something in common: traffic jams. Such road congestion is another example of an externality. The decision of one person to drive has an effect on other drivers.

One way of solving externality problems is to create new markets. In most cases, there is no market for the use of roads. However, if we charge people to use roads, then market incentives come into play. Toll roads are an example of the introduction of a market mechanism to combat congestion problems.

Congestion fees and tolls are in use in some cities around the world, such as London and Singapore.This June 21, 2006, press release from the UK Commission for Integrated Transport provides some discussion of the London system and others around the world: “New study shows road pricing progress,” accessed March 14, 2011, The system in London, started in February 2003, charges drivers for entering the central city area between certain hours. Details of the system are available from Transport for London.Transport for London, “Congestion Charging,” accessed March 14, 2011, The cost in May 2008 was £8 (about $15.60) for access to the charging zone in Central London between 7 a.m. and 6 p.m., Monday through Friday. The system is enforced by a series of cameras that record license numbers and then check them against a record of who has paid for access to the zone. According to the Transport for London, the traffic flow into the zone has been reduced by 21 percent, and there is now less pollution and more cycling in the area.

The Electronic Road Pricing (ERP) system in Singapore, although older, is much more sophisticated. It was introduced in April 1998 along Singapore’s expressways and in the city’s central business district. All vehicles contain a transponder, mounted on the windscreen, into which the driver inserts a prepaid cash card. There are gantries located at various points around the city, and whenever a car passes under a gantry, a toll is automatically deducted. The rates differ for different categories of vehicle: motorcycles and light goods vehicles pay less than cars; heavy goods vehicles pay more than cars.

The most striking feature of the Singapore system is that the charges vary by time of day. Charges are imposed only at the peak hours, and the charges vary within those hours. Thus, for example, a driver passing a typical gantry might pay SGD 0.80 (about $0.58) from 08:00 to 08:05, SGD 1.50 from 8:05 to 8:30, SGD 2.00 from 08:30 to 09:00, SGD 1.50 from 09:00 to 09:25, SGD 1.00 from 09:25 to 09:30, and so on. You can see that these rates are quite finely tuned, with some rates being in effect for only a five-minute period.

The rates just quoted were in effect in mid-2008. By now, they may be quite different because a second feature of the system is that these rates are revised frequently. The Singapore Land Transport Authority has targets for the desired average speed of traffic on Singaporean roads: the target speed for expressways is 45–65 kilometers per hour (28–41 miles per hour), and the target speed for arterial roads is 20–30 kilometers per hour (13–19 miles per hour). Thus if they observe that traffic is flowing below these speeds, they consider raising the rates; if traffic is flowing smoothly, they consider reducing rates. They also adjust rates on a seasonal basis—for example, ERP charges are lower during school vacations.

Key Takeaways

  • Gas taxes and actions to improve fuel efficiency of cars are policies that reduce pollution from cars.
  • In the United States, households benefit from the importation of foreign-produced cars and also from the ability to work at automobile factories owned by foreign companies.
  • The opening of the car market to imports creates some job displacements.
  • In some countries, governments tax the use of roads when they are congested.

Checking Your Understanding

  1. Give two reasons why the government taxes gasoline.
  2. Why might a government choose to limit car access to a city center? What policies are available to a government for doing that?