The demand for ethanol as a gasoline substitute

This paper estimates household preferences for ethanol (E85) as a gasoline (E10) substitute. I develop a theoretical model linking the shape of the ethanol demand curve to the underlying distribution among households of willingness to pay for ethanol. I estimate the model using instrumental variables techniques and data from many retail fueling stations. I find that a $0.10-per-gallon increase in ethanol's price relative to gasoline leads to a 12-16% decrease in the quantity of ethanol demanded. My findings imply that preferences for ethanol are heterogeneous and that a substantial fraction of households are willing to pay a premium for the fuel. This reduces substantially the simulated efficiency cost of an ethanol content standard, since some households choose ethanol without large subsidies, mitigating deadweight losses. (C) 2011 Elsevier Inc. All rights reserved.