A recent Edmunds report shows that used car prices are up on average 10.3%, and for some models over 30%, over the last year. This has been attributed by Radley Balko, Edmunds, and others partly to the governments cash-for-clunkers program. I was and am not a fan of cash-for-clunkers, but I don’t think we know how much of this is due to clunkers and how much is due to falling incomes. In fairness, neither Balko nor Edmunds try to lay the blame entirely on clunkers, and Edmunds even discusses the difficulty of isolating the effects, but it is worth explaining the economics of why else prices may have gone up.

It might seem like common sense that that when people’s incomes go down they decrease their demand for stuff, so prices of stuff should also go down. Thus, we would expect in a recession prices for used cars to fall.  But that is not always the case. There are three types of goods: inferior goods, normal goods, and luxury goods. When income goes up by, say, 10%, demand for inferior goods falls, normal goods goes up but by less than 10%, and luxury goods goes up by more than 10%. It is quite believable that used cars are an inferior good, so that the decrease in incomes has led to an increase in the demand for used cars, which could explain some unknown portion of the price increase we have seen. Without some empirical evidence it is premature to point at the 10% to 30% increases and blame it on cash-for-clunkers. This would make for a good paper topic for some enterprising student….. Or if someone wants to know bad enough to pay for it, I’d be glad to crunch the numbers.

About these ads