Tuesday, August 18, 2009

Clunkers: How much would they be worth, anyway?

There has been a lot of talk about the Cash for Clunkers program. Recently, Jodi Beggs wrote a piece on the economic effects of the Cash for Clunkers program. The article is a nice introduction to how an economist initially thinks about the effects of subsidy programs like Clunkers. It's worth a read.

In her article, Beggs (rightly or wrongly) couches her analysis in a standard supply-demand-subsidy framework, and then concludes with the comment:
On a sidenote, does it bother anyone else that the government can be paying out $4500 for a combined benefit to consumers and producers of at most $2500? Technically, the value to the consumer and producer is even lower than what is stated above if the consumer wouldn’t have purchased the vehicle without the subsidy. Either the government must be getting some decent cash for the recycled car parts or there must be one hell of an environmental benefit to having a smaller SUV as opposed to a larger one.

To see why the combined benefit is "at most $2500," note that Beggs assumes that the minimum price for a consumer to part with his/her car is $2000. Under the clunkers program, the car is destroyed (i.e., scapped and recycled). That's $2000 in value that neither the producer, nor the consumer see. Then, Beggs argues that we have to net out the value of the trade.

That's got the right spirit. To determine how much dealers and buyers value the program, we need to net out the value of the car, but the trade-in price is not a good substitute for the value of the car. Savvy used car salesmen often make the trade-in price seem high, but they might give fewer breaks on other aspects of the sale price.

With these savvy salesmen hiding the price, how do we figure out what value the car-to-be-destroyed is? It turns out that it is easier than one might think: Just subtract the resale value of the used car (net of the clunker-to-used-car conversion costs). When the dealer and buyer negotiate a trade-in, each tries to extract their maximum portion of the resale price. Haggle how they will, they're essentially splitting the resale price.

It's often difficult to figure out how much of an advantage you really got from trading in your car. Just checking the sticker a month later when the car is actually sold by the dealer tells you exactly what number you want to use.

When I was 15, the lowest price used car at the dealership was $1000 (my parents just about bought it for me). Now, it's probably more like $1500 -- though I have to admit I am not in that market anymore. The fact remains, most used cars that would qualify for the clunker program go for at least $2000. Beggs' first approximation is about right.

In fact, for many transactions, the dealer-buyer combined benefit of the $4500 Clunker subsidy is no more than $1500. In terms of other benefits (i.e., less emissions, lighter, and shorter vehicles), Beggs is right. We had better get a good bang for our buck. Otherwise, we just wasted $1.5 billion.

1 comment:

  1. Very good point. I think another thing that should have been looked at is forcing people to buy cars that were made and/or assembled, for the most part, in America. Buying a new car that is made entirely in a different country does not really help our economy. It may benefit it indirectly, but the program would have done more for the U.S. economy if they had some sort of classification system that requires the components of the new car to be a certain percent U.S. made.

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