QoD: You purchase a new car and a year later sell it back to the dealer. What is the loss in value you should expect, as a percentage of the original purchase price?
Answer: 31% loss in value from your original purchase price
- Why do you think this loss is so large since the car is still only one year old?
- What are the reasons that someone would be selling a car back to the dealer after only one year? Why might a dealer be hesitant about buying back a one-year old car?
The lemons penalty reflects the difference between the average quality in the population and the average quality of cars sold, given any observed characteristics. Asymmetric information about the quality of cars means dealers will pay less than the expected value of cars that are owned in the population and this will affect who sells a car. This price discount is the lemons penalty.
This data table below from the report shows how the gap between what a dealer pays for used car compared to its "market value" and how that varies over time. The gap is widest in year one (18% or (0.815-0.692)/.815) and declines to 0% in year 9. Why? You might surmise that the dealer fears that a car being sold back after only a year might just be a "lemon," so they protect against that possibility by not offering much for the car. As a result fewer transactions take place as sellers (if they don't have a lemon) refuse to believe that their car has lost 31% of its value in just one year.
Want to keep the conversation going and help your students understand the difference between buying and leasing cars? Check out this FinCap Friday: Deals on Wheels.
About the Author
Tim's saving habits started at seven when a neighbor with a broken hip gave him a dog walking job. Her recovery, which took almost a year, resulted in Tim getting to know the bank tellers quite well (and accumulating a savings account balance of over $300!). His recent entrepreneurial adventures have included driving a shredding truck, analyzing executive compensation packages for Fortune 500 companies and helping families make better college financing decisions. After volunteering in 2010 to create and teach a personal finance program at Eastside College Prep in East Palo Alto, Tim saw firsthand the impact of an engaging and activity-based curriculum, which inspired him to start a new non-profit, Next Gen Personal Finance.
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