Reference-dependent electric vehicle production strategy considering subsidies and consumer trade-offs

Highlights

• The performance of both electric vehicles (EVs) and internal combustion engine-power vehicles (ICEVs) influences the EV production decisions.

• A loss averse EV manager produces less and obtains less the expected utility than a risk neutral one.

• Subsidies help decrease the EV breakeven quantity, increase the optimal quantity, offset the influence of loss aversion.

• Subsidies should be adjusted according to the performance of both EVs and the ICEVs, demand heterogeneity, and local conditions.

• The high ICEVs costs help offset the influence of loss aversion, whereas the high EV costs enhance loss aversion.

Abstract

In this paper, we extend previous reference-dependence newsvendor research by incorporating both consumer trade-offs and government subsidies to evaluate the relevant influences on the optimal electric vehicle (EV) production decisions. We present the properties of the model, derive the closed-form solutions for the model given the relevant constraints, and use numerical experiments to illustrate the results. We find that subsidies, loss aversion, the performance of both EVs and internal combustion engine-powered vehicles (ICEVs), and the coefficient of variation of demand are significant factors influencing the optimal production quantity and the expected utilities of EV production. The high selling price and other high costs of ICEVs help offset the influence of loss aversion, whereas the high costs of EV enhance loss aversion. Our study enriches the literature on subsidies for EVs by establishing a behavioral model to incorporate the decision bias in terms of loss aversion at the firm level. These findings provide guiding principles for both policymakers and EV managers for making better strategies to promote EVs in the early immature market.

Introduction

As one of the most important actions aimed at meeting the climate change targets and energy challenges, the development of electric vehicles (EVs) has been encouraged by many governments. Financial incentives for EVs have become one of the most notable government interventions (Tsang et al., 2012). Almost all electric vehicles on the market receive government subsidies to a certain degree. However, the government subsidy policy is just one aspect.

The successful development of EV market includes at least three aspects: the EV production strategy, government incentive policies, and the adoption of EVs by consumers. Factors of these three aspects interact with each other, and some factors may offset the positive effects of subsidies, which we address in this paper. An interesting question is how the EV managers make production decisions after considering government subsidies and consumer trade-offs between EVs and internal combustion engine-powered vehicles (ICEVs). The answer to this question is not straightforward.

Managers face several barriers when making EV production decisions, including the low adoption rate of the EV market, high initial production costs, and consumer trade-offs between the attributes of EVs and ICEVs such as purchase cost, cruising range, and charging time (Dimitropoulos et al., 2013; Liu, 2012, Daziano and Chiew, 2012, Daziano, 2013, Lin et al., 2013). These barriers may lead to mixed effects of government incentives for promoting EV production and adoption (Michalek et al., 2012). The decision making behavior of the EV manager is also governed by human behavioral and psychological rules, such as loss aversion (Kahneman and Tversky, 1979, Tversky and Kahneman, 1991). The human decision bias brings another uncertainty when predicting the impact of subsidies on EV production and the optimal EV production strategy.

Although the literature on EV policy and consumer choice is extensive, few studies have addressed the impact of incentive polices on the production decisions of EV managers. Because subsidies compete for limited government resources (Tsang et al., 2012) that could otherwise be used to deliver other essential services, it is important to estimate the economic influence of subsidies on EV production. EV managers who are motivated by subsidies intend to make decisions to produce more EVs. However, the market adoption is very limited. It is essential to consider consumer adoption when making EV production decisions.

In this paper, we present an analytical model to investigate the influence of subsidies and consumer trade-offs on the optimal EV production strategy with consideration of the loss aversion of EV managers. The analytical work is based on the newsvendor model (see Khouja, 1999, Qin et al., 2011 for reviews). We provide the closed-form solutions to the model and show properties of the solutions. The proposed model enriches the research literature on government subsidies by establishing a behavioral model to incorporate the decision bias in terms of loss aversion. The findings provide guiding principles for both policymakers and EV managers to determine better strategies to promote EVs in the early immature market.

The rest of the paper is structured in the following manner: we review the research background to identify the missing links in the literature in Section 2. We define the model and derive the properties of the model in Section 3. We then illustrate the relevant properties using numerical experiments in Section 4. We discuss the findings and present conclusions in Section 5.