A Theoretical Model of Competitive Equilibria in the New Car Market

Abstract

In the United States, the automobile purchase decision is consequential for both households and car producers. In households, adults typically own their own vehicles for personal use such as commuting to work or college. The need for multiple, safe cars per household represent a significant allocation of household income on an ongoing basis as old vehicles are replaced. Customer ne eds are represented by groups of demand utility functions which specify the demand for increas ingly expensive safety features and styling changes. Auto manufacturers respond to the need for a variety of styles and safety features by producing vehicles in as many as 16 different product-market segments. They offer multiple financing options such as leases, late models, and stretching out payments to accommodate capital rationing by their customers. The quantity sold in each segment provides the profit per segment which adds across segments to provide the overall profit for the firm. This is a monopolistically competitive environment in which brand loyalty drives sales per segment, with each segment being considerably different from others in vehicle characteristics and customer income. This paper theoretically develops the demand utility functions within each segment, develops the producer’s profit function and then equates the supply and demand functions to obtain the optimal quantity per segment. Practical implications are discussed. One such implication is that the quantity of sales may not be realized in any one market, so that sales may have to be realized across markets for auto firms to achieve consistent, long-term profits. Thus, our quantity specification may provide a justification for the globalization of the auto industry.