No Mystery in the Current Used-Car Market
By Pierre Lemieux
Consider a story in Monday’s Wall Street Journal regarding the current market for used cars, “Looking to Buy a Used Car? Expect High Prices, Few Options (May 10, 2021).” Financial press reporters are usually more reliable than their colleagues in the general media because they have a knowledge of supply-demand analysis acquired from economic classes or at least on-the-job training. But it is not always true and finding errors in the financial press is a good exercise and an easy hunt. Similarly, to use a formula from the late Financial Times columnist Samuel Brittan, “businessmen are paid to operate the system rather than understand or expound it” (Capitalism and the Permissive Society, Macmillan, 1973).
The WSJ report contains some useful information provided it is interpreted in light of economic theory. With the end of the pandemic, demand for automobiles increased while their supply lagged partly because of a microprocessor “shortage.” I believe that there has been more a price increase than an actual shortage, but it is true that about half of the microprocessors going into cars are non-generic and that recent supply disruptions may have generated a real but temporary shortage. For our purpose here, it suffices to understand that new car prices have increased and that this caused a large increase (perhaps as much as 17% since January) in the prices of used cars as the two goods are substitutes.
The Wall Street Journal quotes a businessman in the car industry:
“What is normally a depreciable asset has been appreciating,” said Phil Maguire, who owns Maguire Family Dealerships, a group of 13 stores in New York state. “It’s certainly surreal, and I guess we can all agree that it’s an anomaly.”
There is nothing surreal in this, even if the current circumstances are not often repeated on such a large scale. (Go back to Samuel Brittan’s quote!) A used physical asset mainly depreciates because the demand for it (the whole demand curve) decreases. If demand for an asset increases, it will appreciate ceteris paribus. This applies not only to Renoir paintings but also to vintage cars, whose supply is fixed. It can happen to used cars in general.
The author of the WSJ story, although not always immune to economic confusion, was professional enough to quote another opinion confirming that depreciation is a matter of supply of demand, not a physical law of the universe:
Scott Smith, president of Smith Automotive Group, a dealership chain in the Atlanta area, said he recently paid close to the original sticker price for two-year-old Nissan Sentras at auction.
Supply and demand determine the value of an asset and thus its depreciation or appreciation. More generally, prices are determined by supply and demand. When outside interference coercively imposes maximums or minimums, the result will be shortages and surpluses (if the price controls are set at levels that happen to be binding). That shortages are not occurring in the used-car market is a reflection that the “price-gouging” laws triggered by the declarations of emergencies following the Covid-19 epidemic are expiring in several states (many of them this month) or are not effectively enforced. (The diversity and thus enforcement difficulty of these laws in federal America have limited economic dislocations and prevented a worse recession.)
Many people seem to think that the used-car prices provided by the Kelley Blue Book and similar websites determine the prices of these cars. It is of course an error. The system works exactly and necessarily the other way around: the Kelley Blue Book finds the prices actually paid on the market, on the basis of which it tries to estimate the price or value of a specific car given its mileage and condition.
Another economic fact that is important to understand–especially in view of the current acceleration of inflation just reported in this morning’s Wall Street Journal–is that the price of used cars has little to do with inflation (“Consumer Prices Jump as Economic Recovery Picked Up,” May 12, 2021). One must distinguish changes in relative prices, which happen with or without inflation, and change in the general level of prices, which defines inflation (or deflation). In April, for example, prices of used cars jumped by 10% and the price level (the average of all prices) increased by less than 1%, which means that the relative prices of used cars increased by more than 9%–that is, relative to the other prices in the economy. In other words, changes in individual prices don’t cause inflation; but an actual price change includes both the relative price change and inflation.
Thus, we can say that the steep rise of used-price cars has basically nothing to do with inflation. This morning’s WSJ report is confusing about that.