First, let’s think about how the program works. From the consumer’s perspective, you get either a $3,500 or $4,500 rebate on the purchase of a new vehicle if you are trading in a “clunker” for a more fuel efficient vehicle. The details of qualifying trade-ins can be seen here. From the car dealer’s perspective, it takes the clunker and hands it over to some sort of government entity to be destroyed. (Technically I think the cars get recycled and don’t just end up in a landfill somewhere, since that would be comically counter to the proposed environmental aspect of the program.)
As a result, the government rebate acts as a subsidy on the purchase of a new car. However, from the (smart) consumer’s perspective, the effective rebate is not the entire $3500 or $4500. This is because the consumer is forgoing whatever trade in value he would have gotten otherwise. If we consider that there are lots of dealerships that offer a $2000 or so minimum for a trade, the net rebate amount is actually a maximum of $1500 or $2500. If the consumer has a halfway decent car, this amount is going to be even lower since the net rebate is the difference between the government cash and the value of the trade. (I would hope that people aren’t turning in vehicles that are worth more than $4500!)
I hope that you now see that the cash for the clunker is a net subsidy of somewhere between $0 and $2500. Economics 101 teaches us that the benefits of a subsidy are generally shared between consumers and producers. Consumers benefit because they pay less out of pocket than they would have without the subsidy. Producers benefit because they receive a higher price than they would without the subsidy. This can be seen in the following diagram:
Some relevant points:
- Demand for cars increases (i.e. people want more cars) as cars get cheaper. Hopefully this is intuitive to you.
- Producers want to supply more cars if they can get a higher price for them. They will generally figure out how to produce more cars by running assembly lines closer to capacity, having employees work overtime, etc. (The higher price makes this profitable where it wouldn’t be otherwise.)
- The subsidy is effective in encouraging sales of more cars…how effective depends on how reponsive producers and consumers are to price. The increase in quantity of cars sold is greatest when consumers and producers are very price sensitive.
- The price that producers get for the cars goes up, but not by the full amount of the subsidy.
- The price that consumers pay out of pocket (net of the rebate) for the cars goes down, but not by the full amount of the subsidy.
- The two price changes above add up to the amount of the subsidy.
- You can’t see this directly in the graph, but if consumers are more price sensitive than producers, consumers will see less of the benefit from the subsidy than the producers. (The opposite is also true.)
- Again, you’ll have to take my word for this, but this outcome doesn’t change depending on whether the subsidy is given directly to the consumer or to the producer.
Glad we got that out of the way. Now that we understand a bit of economics, I want to introduce you to an article from edmunds.com about how consumers are getting ripped off because they are paying higher sticker prices for the cars because of Cash for Clunkers. Now, this is partly true and partly not true:
- Those consumers who are getting the Cash for Clunkers rebate are not paying a higher price once the rebate is taken into account, they just aren’t capturing the full value of the rebate.
- Those consumers who don’t have a clunker to trade in are getting crowded out of the market to a degree. This is because the car dealers aren’t going to cut a better deal for a non-clunker customer when there are plenty of less cash-constrained clunkers customers lining up out the door. In this way, customers without qualifying trade-ins are also subject to the higher prices.
Technically, the relevant text of the article is the following:
Edmunds.com, the premier online resource for automotive information, warns consumers that car prices are climbing as the “Cash for Clunkers” frenzy is influencing the marketplace.
“Since the program launched, we’ve seen that shoppers are getting less of a discount off sticker price for new cars,” notes Senior Analyst Michelle Krebs in her report on Edmunds’ AutoObserver.com. “In some cases, they are choosing less expensive trim levels and option packages than had been typical in recent months, but paying more for them.”
“In truth, this program launched at the worst possible time of the year,” opined Edmunds.com CEO Jeremy Anwyl. “The annual summer sell-down typically creates a rush of activity for the industry, and this year that rush came right after automakers cut production in response to the floundering economy. It’s a simple case of supply and demand, bolstered by a reduced level of negotiation on the part of excited clunker traders. Add to this the automakers’ unseasonable reduction in incentives and the message is clear: if you buy a car this summer, you should expect to pay higher prices.”
In fairness, the “getting ripped off’ implication here is subtle…but then you have subsequent articles with fun headlines like Don’t Let Cash For Clunkers Short You. I would argue that this really should read “Don’t Let the Laws of Economics Short You”, but that doesn’t have the same ring to it.
(Warning for the future: I don’t think I am done talking about clunkers yet- it’s really a nice playground for economic snark. Whee. 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. =P)