Wednesday, July 15, 2009

Chicago: Why we have good apples, but few old cars

I previously discussed how driving and other aspects of life are surprisingly interesting in Chicago. From twice-a-week fireworks to downtown and the lake, Chicago obviously has a lot going on, but there's much more beneath the surface. This post is a case in point.

Chicago streets have a lot of nice cars: BMWs, Audis, Hummers, Range Rovers, etc. Even the less expensive cars are relatively new. This is in stark contrast to the stock of cars in Montana. Not only are such fancy cars rare in Montana, but the fleet of vehicles is much older -- at least based on my casual observation. Our 1997 Oldsmobile Cutlass is a dinosaur in Chicago, but it does not stick out too much in Montana.

This begs the question: Why are there so few old cars in Chicago? Economic theory gives two reasons we would expect to see fewer old cars in Chicago.

Alternative transportation options. The city provides public transportation, which is a good substitute for an old vehicle, but a poor substitute for a BMW. People who just want to get from place to place take the train or bus. This decreases demand, and therefore, quantity of old low quality vehicles. As a result, it's not surprising to see that most cars on the road are fancy. If public transportation were a perfect substitute for driving, the people with luxury cars would be the only ones with a reason to drive (i.e., showing off).

There's another compelling -- and economically fascinating -- reason to expect fewer old clunkers on the road in Chicago than in Montana.

The fixed cost of driving. Compared to Montana, there's a high fixed cost of driving in Chicago. License and registration is approximately $50 per year in Montana. Once you take care of all of the licenses and stickers that Chicago requires, you've spent $150 per year. You might say that it's only a hundred bucks, but keep in mind that this is $100 per year. To keep your car appropriately licensed for five years costs $500 more in Chicago.

More importantly, parking in Chicago is expensive (and full of hassles). In our neighborhood of Hyde Park, it costs upwards of $100 per month to secure a parking spot in a paid lot. Even the University of Chicago charges $80 per month, and at that price, they have a waiting list. In contrast, paid parking in Montana is rare. Paid parking at Montana State University for a year costs about the same as a spot in a typical Chicago paid lot for a month. Annually, parking costs about $1000 more in Chicago.

Over five years, the fixed cost of driving in Chicago is about $5,000 more than it is in Montana. That presumes that you pay to park your car, but it does not account for the significant hassle of owning a car in the city. For this reason, the fixed costs of having a car could be higher or lower: $5,000 is probably a fair estimate of these costs. It's a convenient number anyway.

How do these fixed costs this affect what kinds of cars city-dwellers purchase? If a 10-year old car costs $5,000 and a comparable brand new car costs $15,000, that's not really the right comparison if there are significant fixed costs to driving. In both cases, the buyer also has to pay the fixed costs. Old cars cost just as much to park and there's no discount on the license and registration.

Add in the fixed costs and we're comparing $10,000 to $20,000. On account of fixed costs of having a car, the new car went from being 3 times the price of the old car to just twice the price. On account of this effect, buying new cars in Chicago looks relatively more attractive than in Montana.

What do apples have to do with it? If you care to know whether my fixed cost story is well-founded, it is precisely the Alchain and Allen (1964) conjecture: "a per-unit transaction cost lowers the relative price of, and raises the relative demand for, high quality goods." This is the Shipping the Good Apples Out theory, which is established economic theory.

In the original context, Alchian and Allen noted that you are more likely to find a good apple in Chicago than in Washington State (where they grow the apples). The reason? Every apple -- good or bad -- incurs the same shipping cost to get to Chicago. Suppose the shipping cost is $0.25 per apple; good apples sell for $0.75 and bad apples sell for $0.25 in Washington. After adding in shipping costs, good apples cost $1 and bad apples cost $0.50 in Chicago.

In this example, people in Chicago only have to give up two bad apples to get one good one. Therefore, even though the higher price means they buy fewer apples overall, Chicagoans demand a mix of apples that is skewed toward good ones. Hence, Washington apple orchards ship the good apples out.

For the same reason, we see few old cars in Chicago: driving is more expensive in Chicago whether you have a clunker or a BMW. This fixed cost of driving has two effects: (1) As fewer people are willing to drive, there are fewer cars on the road than otherwise, and (2) people tend to buy more expensive vehicles.

Or, as that guy who just passed you in the red Audi would say: Driving is expensive in Chicago. You might as well do it in style.

2 comments:

  1. As I walked to school today, I had a few other thoughts about what drives the difference in types of cars:

    1. Income differences. If Chicagoans are richer, they'll tend to have newer cars.

    2. Gas is more expensive in Chicago. This could have lots of different effects. But, it might make newer fuel-efficient cars more attractive.

    3. The potholes are deeper, and the winter roads are saltier. Hence, cars wear out and rust out faster.

    I'm sure I didn't cover all possible explanations. I really just wanted an excuse to talk about apples... so, readers: Do you have other ideas?

    ReplyDelete
  2. Hi Tony

    Shipping the good apples out is much simpler. You ship the more expensive apples out because it cost just as much to ship a pound of apples that will sell for $2.00/lb as it does to ship apples that will sell for$1.00/lb. since you make more money on the $2.00 apples the shipping cost is a smaller percentage of the sales price so it is more profitable.

    I would guess you see more of the expensive cars because those who would buy less expensive cars have less to spend on parking etc and have public transportation at a cost effective alternative. Hence, there is less purchasing and driving less expensive cars. There is an additional cost of public transportation that the lower income people can pay because it doesn't cost money. They pay in the "hassle" or inconvenience of public transportation.

    Those with higher incomes can not only afford a nicer car, but the parking etc and will pay the money for parking etc. rather than the hassle or inconvenience of public transportation. I think it comes down to how much each transportation option is a percentage of a persons income and how much the hassle factor is worth to each. I.e. nicer car or not is a function of income and hassle factor preference. (in academic speak w/o the math symbols, sort of)

    Fletch

    P.S. Oh, just figured out you are now at University of Chicago. Congratulations! You are officially really really really smart about economics. Just wait till you actually take some classes. :)

    P.P.S. How is that for lack of humility. Me suggesting to you another way of looking at the situation. My undergrad was in finance and a long
    time ago in a galaxy far far away. Though my gpa in more econ courses was more than full point above my finance gpa. I am a student of economics just not for any kind of credit. (yet, he says optimistically)

    ReplyDelete

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