Why are Car Dealers Selling Old Crocks?

why-are-car-dealers-selling-old-crocks

“Lemons” or “cherries”? Even searching for answer to this rather fruity question can earn you a Noble prize in economics. In 2001 this prize was gained by George Akerlof, who was also honoured for a special study called The Market for “Lemons” 

“Lemons” in slang refer to low-class second-hand cars, which have a fault under their hood caused by exhaustion of the material for example. On the other hand “cherries” are well-preserved second-hand cars, still relatively in good shape, which were not used as often as the lemons. Akerlof focused on the market with second-hand cars in the mid 60s, because he researched broader economical cycles. His other concern was why people buy a new vehicle instead of a second-hand vehicle and vice versa.

Akerlof attained knowledge, seeing that the buyer in used-car lots never have as much information as the seller, they cannot be certain whether they are buying a “lemon” or a “cherry” (this phenomenon in economics is called asymmetric information). Therefore buyers consider these cars as average quality vehicles and they are willing to pay only for average quality.  But this means that the owner of a car in perfect shape cannot sell it for a price, which would match its quality. Owners of these cars will obviously not sell them in second-hand car lots. The withdrawal of “cherries” from the market will however lead to another decrease of expectations of the buyers – in relation to the quality of used cars. In consequence, owners of average quality cars will leave the market as well. Result? “Quality” is completely removed from the car lots and only the old crocks are sold.

Parallels with the “lemon” market exist also elsewhere, for example in the insurance industry. The demand for vehicle insurance will be higher in those, who also have higher probability of having an insurance occasion (for example irresponsible drivers). The insurance company is however in information disadvantage (asymmetric information), because it does not know the nature of the driver. With increasing number of accidents of bad drivers, there will also be an increase of vehicle insurance for everyone else and this will push away responsible drivers from the market. Only the blunderers will stay insured.

So how can we make life harder for the irresponsible drivers in order to prevent the decline of responsible drivers? Economists are looking for the answer to this question. Eef Delhaye from Catholic University in Leuvene, Belgium came to a positive response to this question in her work called The Enforcement of Speeding: Should Fine Be Higher for Repeated Offences?. 

Delhaye started from the ability of people to drive a vehicle, which obviously differs in every one of us leading to bad and good drivers on the roads. The bad ones can break the law even though they try not to. The expected costs of their (potential) accidents are higher than in the case of good drivers, which means they should pay higher penalties. But how would the police distinguish between the good and bad drivers? They do not have it written on their foreheads. This is another example of asymmetric information. Delhaye therefore comes up with a solution- option to look up the history of nuisances of every single driver (for example Czech Republic established the so called point system, where every violation would add black points to the driver and when the number of points reaches 12, the driver automatically loses his driver license). Even though the driver did not have an accident he could have violated the law several times.

American researcher Michael Gebers proved in his analysis, that the amount of previous, relatively negligible highway nuisances like speeding, ignoring the STOP sign, not using the seat belts are most reliable indicators of potential chance of an accident. More little misdemeanours lead to higher probability of a fatal incident often resulting in to death.

And this goes also for insurance. More little misdemeanours, more black points (in point system) should lead to higher insurance costs, which the driver should pay. It can be predicted, that the bad driver will end up in a serious accident- insurance event. Therefore it is useless to wait until this happens.

An argument that the insurance refers to a vehicle rather than to the driver? The owner of a car should be motivated in a way that he will borrow his car to only responsible drivers and not to a hot-rodder. We usually know who are we borrowing the car to and we also know their capabilities.

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