New vs. Used in the auto industry

Eric Perkins

My final paper will focus on a discussion of the new and used auto markets. If you have any thoughts or comments about my topic, I’m all ears.

Cars are clearly a durable good, in that they (mostly) do not wear out quickly. As a result, a large secondary market for used cars allows consumers who wouldn’t normally be able to afford a vehicle to maximize their utility and preferences through a car that likely has a little less tread on the tires. The secondary auto market, more-so than most other secondary markets, is very competitive given the rapid technological advancements and the ease with which current owners can dispose of the cars they no longer prefer.

While a “fashion effect” exists in the new market (i.e. car manufacturers are able to charge a premium to early adopters of models), such an effect has not been shown in the secondary market. Instead, the used car market is subject to obsolescence and enhancement effects (i.e. the relative change in depreciation has a function of consumer preferences). What factors effect consumer preferences, prices, and demand in the used car market?

There is robust research on demand in the auto industry as a function of preferences, but a majority of the research focuses on the primary rather than secondary markets. This paper will attempt to examine the consumer’s perspectives of the used car market and the factors that influence their choices. These factors include, but are not limited to, product reliability, primary market prices, consumer knowledge/information, preferences, technological change, and the conditions of the primary market relative to the economy. I will also examine how adjustments and changes in the primary market for new cars leads to change in the secondary market, the level of efficiency in these adjustments, and the strategies employed by manufacturers to manage the demand for new cars through the used car market.

My paper is organized as follows…

Examining the Current State of the industry:

—Following the 2008 crisis, many Americans fell behind on their mortgages and became unable to secure financing
—The rise of student debt for young people further added to the inability to secure financing
—Rising fuel prices have also contributed to a movement towards public transportation
The “re-urbanization” of the United States also plays a role in this cultural shift
—Durable goods are typically hit the hardest during a recession (i.e. housing market, auto market)
—Despite this, Autodata reports that November sales of new light-vehicles are the highest since the 2008 crisis
—Ludwig Willisch, BMW’s North American chief, has even called North America a “growth market” that they can “rely on for stability” in the long term
—How can this be the case?
Reasons for Optimism:
—The current age of the light vehicle population is at an all-time high (approximately 11 years)
Like any durable good, consumers of automobiles drop out of the market until their vehicle needs to be replaced.  In the long run, as more drivers are introduced into the market, pent-up demand should accumulate
—The tightening of the supply/shortage of vehicles in the secondary market
This pushes prices upwards in the secondary market, and during a recession this can cause consumer preferences to shift towards relatively cheaper (i.e. you get more bang for your buck) new cars
Consumer Choice:
—The durability of automobiles leads to a competitive secondary market of used cars that matches buyers who cannot afford new models with current owners who desire to dispose of their car while it still has market value
——Due to the long-life and resale values of automobiles, consumers can consider them a capital investment
Dynamic Oligopoly Model:
—New automobiles today become used automobiles in the future
The difference between the utilities of the available new automobiles in the primary market to those of the automobiles currently owned by consumers can utilize transaction costs to explain holding behavior (Schiraldi 2011)
—Given the decrease of supply in the secondary market, this model would predict that the market for used cars would become more illiquid
This would result in higher transaction costs in the secondary market, shifting consumer choice preferences towards the primary market
Conclusion:
—The outlook of the American auto industry is promising following the Great Recession thanks to the potential stability of new car sales. Hopefully the trend continues, because doing so would further increase the appeal of new cars, increase consumer spending, and subsequently help to get the rest of the country back on its feet.

Bibliography:

Ginter, J. L., Young, M. A., and Dickson, P. R. (1987). A Market Efficiency Study of Used Car Reliability and Prices. The Journal of Consumer Affairs, 21(2) 258-276.

Hortascu, A., G. Matvos, C. Syverson, and S. Venkataraman. (2010). “Are consumers affected by durable goods makers’ financial distress? The case of auto manufacturers.” Working paper, University of Chicago.

Levinthal, D. A., & Purohit, D. (1989). Durable goods and product obsolescence. Marketing Science, 8(1), 35-56.

Purohit, D. A. (1992). Exploring the Relationship between the Markets for New and Used Durable Goods: The Case of Automobiles. Marketing Science 11(2) 154–167.

Schiraldi, Pasquale. (2011). Automobile Replacement: A dynamic structural approach. RAND Journal of Economics, 42(2), 266-291.

Ted, H. C., & Su, Y. (2010). Will the U.S. auto market come back? Business Economics, 45(4), 253-265.

Wood, W. C. (1994). The cost of driving a car off the dealer’s lot. The Journal of Consumer Affairs, 28(1), 130-130.

Zeng, X., Dasgupta, S., & Charles, B. W. (2012). How good are you at getting a lower price? A field study of the US automobile market. Journal of Consumer Policy, 35(2), 255-274.

3 thoughts on “New vs. Used in the auto industry

  1. This is a particularly interesting topic given that this is about a choice that all consumers (who drive) will face. It definitely seems like there would be an inverse relationship between how the economy is performing and used car sales, that is a poor performing economy would increase used car sales. It is reassuring to see your analysis that you see a leveling and potential uptrend in new car sales, so hopefully this is a leading indicator that the economy overall will continue to see improvement and not dip into a double-dip recession, as you mentioned in your presentation.

  2. I wonder if the developments of “greener” cars that use less gas will cause significant increases in demand for new cars. If people think they can save money in the long run off gas efficiency it seems to me they could want to buy a new car over an old one. Future higher real gas prices would increase the demand for efficiency.

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