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.