What's the effect of the used car market on car price?

While justifying his decision to sell a one-use textbook to his students, a BYU econ professor states:

A word about the Kearl text. I do not receive any royalties and have no economic interest in the text – when you buy the text, not a single penny goes to me. It’s designed to be a “disposable,” one-use text in order to keep the price down. (The used book market actually drives up the price of texts – to see why, think of what would happen to car prices if used car sales were not permitted.)

1. How does the used car markets drive up the price of the good? With an used market, the buyer is willing to pay more, knowing that he can resell later. However, without an used market, everyone is forced to buy new cars, raising demand, and thus raising the price of new cars. How to think about these countervailing effects?

2. Are the used books and used cars market actually analogous like the professor suggests? The professor and his publisher have a monopoly on the new textbook, but no one controls the new car market. Therefore, if people keep reselling text, the publisher will use their monopoly and raise the price of new books to compensate. In contrast, car manufacturers can't do so due to competitive pressure.

• Good question! I'm struggling to get around it. Will think more. – luchonacho Apr 25 '17 at 20:05

OP,

imagine that there are two kinds of people, rich and poor, and no market for used books. Rich people are willing to pay more for new textbooks. Poor people cannot afford to buy new textbooks. In the absence of a market for used books, poor people will not buy textbooks.

Imagine now that there is market for used books. Poor people are now able and willing to pay second hand textbooks. And rich people now have someone to sell the books too once they are done using these books.

A market for second hand textbooks raises the price of textbooks because some people are not able and willing to buy new textbooks but are willing to buy second hand textbooks. In the absence of such a market, they'll spend their income on other goods that they deem more important.

Think of it otherwise this way. In the absence of a market for used textbooks the full value of a textbook is not exploited because some people who would wish to trade with one another cannot trade with one another.

Hope that this helps.

• I cannot see the logic of your argument. Can you please explain it better? – luchonacho Apr 25 '17 at 20:04

So, there's a monopoly in place for the production of new books, so the actual price depends on the (inverse demand) price function. The monopolist will maximize profit as such: $\max P(x)*x-C(x)$, for some $x$. Here, $P(.)$ is the price function, $C(.)$ is the cost function, and $x$ is the quantity of goods sold.

Thing is, with a used good market, now we have an intertemporal problem. It's up for grabs how the monopolist will compare against the future. We do know that a bigger $x$ in $t_0$ will mean less demand on $t_{1},t_2,...$ . The problem can be something like: $$\max\sum\limits_{t=0}^\infty{\beta^t*(P(x_{t-1},x_t)*x_t-C(x_t))}$$ $$st.\ x_{t+1}=(1-\rho)x_t,\ x_{-1}=0$$

Here, $\rho$ is the fraction of book in $x_t$ that will be sold as used books in $x_{t+1}$.

Now, conclusions: the final price from the editor should be higher. Why? Because if the demand that the editor has to satisfy is smaller (because $x_{t-1}>0$), then they can sell to a higher price, to match the minimum propensity to spend for $x_t$, assuming that the marginal cost allows it. If there's an exponential discount, everyone will update prices based on that, and it's expected that older books have lower price. Note that it's assumed we can build a book with just broken pieces of older books... ah well...

If there wasn't a used good market( $\rho=1$), the editor would have to satisfy a constant demand, and you solve it just for one period (which will stay the same afterwards). The price for new books will be below the one you calculated above.

• On the consumer (student) side, they would have greater resistance to buy books that cannot be resold. There would be pressure placed on the professor to find cheaper alternatives. In other words, there should also be an effect on total demand, on top of the competition with old books. – Brian Romanchuk Apr 25 '17 at 21:20

In short, a buyer wants a way to make revenue back on the initial investment of a car, if this isn't possible ( a used car market doesn't exist) then the buyer may find another investment opportunity and avoid cars altogether. However, without a used car market, demand for new cars would increase, presuming cars are a necessity, and so therefore would the price. The price of new cars could possibly reduce if there is a used car market as the dealers will want new stock leaving so that they don't stop trading.

From what I can understand, in the context of the used books market, lets assume that there is set, finite amount of demand for the books. When there is a used books market, the demand first goes to the used books market and finishes up the supply in that market. The remaining demand then goes to the new books market (the professor/publisher). To compensate for the loss in demand, the publisher would therefore have to raise prices of the new books.

Now for the cars market, when there is no used cars market, everyone is indeed forced to buy new cars which raises demand and consequently price. However, you are assuming that cars are a necessity and that the demand transfers 100% from used cars to new cars.

Some people maybe only purchasing cars from used cars market because they see the value in the lower price. When there is no longer a used car market, if the price of the new car remains the same, then people would deem that price to be too expensive since they are unable to resell it later on and ultimately choose not to buy at all or opt for alternatives. This actually reduces demand. To capture the market of such consumers, the car companies would ultimately reduce prices to get the market share. This is from the Bertrand competition model point of view.

In actual fact, Bertrand competition are not seen and huge companies work with each other more often then they engage in price wars. Now consider the Cournot competition model where inverse demand for the good is given as P = a - bQ (i.e. law of demand - when the price goes up, demand must go down ceteris paribus.) Since there is no used cars market, then demand for new cars market has gone up, the car companies produce more output (Q has gone up), ceteris paribus, P will come down. Just to reiterate, if there is a used cars market, then total output (Q) would be lower, therefore P will be higher.

Note that both the Bertrand and Cournot model dictates that prices will go down without a used cars market, just that the Cournot model reflects the actual situation clearer.

This is just my understanding and I hope it helps! Let me know if I am wrong in anyway! cheers :)