WOLFSBURG, Germany—Volkswagen AG is doubling down on its bet on the lucrative U.S. market, unveiling plans to make a key new product in Tennessee and to form an engineering team that would better tailor vehicles for American buyers.

On Monday, Europe's largest auto maker by sales said it would pump $900 million into its Chattanooga, Tenn., plant to build a seven-passenger sport-utility vehicle there by late 2016. The move would add 2,000 new jobs, VW said, and could increase the role of U.S. manufacturing in the German auto...