ECO 550 SU Economics Challenges in Car Leasing Case Discussion

PREPARATION

To prepare to complete this week’s discussion, review the following resources on risk vs. uncertainty:

Decision Making Under Uncertainty.

Corporate Decision-Making: Is Hindsight 20/20?Links to an external site.

Your instructor may also post additional resources to help further explain concepts related to this week’s discussion.

CONTEXT

You will need to understand Asymmetric information and Imperfect information to complete the discussion.

• Asymmetric information is where one party in the transaction has more information than the other party in the transaction.
• Imperfect information is a situation in which neither party has perfect information about the good/service being exchanged in a transaction. Such goods and services are sometimes referred to as “experience goods.”

Asymmetric information and/or imperfect information can cause two forms of market failure:

• Adverse selection, or
• Moral hazard.

POST A RESPONSE

In the late 1990s, car leasing was very popular in the United States. A customer would lease a car from the manufacturer for a set term, usually two years, and then have the option of keeping the car. If the customer decided to keep the car, the customer would pay a price to the manufacturer, the “residual value,” computed as 60% of the new car price. The manufacturer would then sell the returned cars at auction. In 1999, the manufacturer lost an average of $480 on each returned car. (The auction price was, on average, $480 less than the residual value.)

For your discussion post, address the following within the context of the above scenario:

1. Why was the manufacturer losing money on this program? Was this a problem of adverse selection or moral hazard?
2. What should the manufacturer do to stop losing money? Will rational actors use rules of thumb?