South-Western College Publishing - Economics  
Car Leasing Runs Out of Gas
Subject Consumer equilibrium, comparative statics
Topic Equilibrium
Key Words Leasing, financing, consumers, incomes, loans, incentives, interest.
News Story

The leasing of vehicles hit an all-time high in the first half of 1998, accounting for 33.8 percent of the market. However, in the first half of 1999, the share fell to 32.2 percent, reflecting a drop in volume for the first time in eight years. It is expected that the lease share will decline to 29 percent in 2000. Instead, consumers are returning to traditional financing.

One reason is that the economy is strong. When incomes are rising fast, consumers tend to buy vehicles, but when the economy is slower, they tend to lease more because of lower monthly payments. Actually, while higher-income men are leasing less, upper-income women are leasing more, perhaps because buying a car is more of a status symbol for men.

Another reason is that auto makers are offering fewer leasing deals with small down-payments and low monthly payments. In the past, they had been too optimistic about the value of a car at the end of the lease. Banks had made similar errors and some no longer back leases. Cash incentives and low-interest loans are more likely in the future.

(Updated October 1, 1999)

Questions
1. Consumers spend their incomes on leasing cars as well as other goods. Draw a diagram with car leasing on the vertical axis and all other goods on the horizontal axis. Add a budget line and an indifference curve that is tangent to the budget line. Mark the initial equilibrium.
  a)Incomes have risen over recent years. Show the effect of this on the budget line.
  b)Higher-income men have reduced the number of cars they lease. Draw a second indifference curve tangent to the new budget line which is consistent with this fact. Mark the new equilibrium combination of goods bought.
  c)What kind of good is a leased car for an upper-income male? Explain.
2. Upper-income women are actually leasing more cars as their income rises.
  a)Draw a second consumer equilibrium diagram showing the initial and subsequent equilibria.
  b)What kind of good is a leased car for an upper-income woman? Explain.
  c)What line or curve on your diagrams distinguishes the upper-income men from the women and causes their responses to higher incomes to be different?
3. Lease deals are now more expensive.
  a)Draw a third consumer equilibrium diagram showing the consumer in initial equilibrium. Mark the combination of goods bought.
  b)Show how the increased price of a leased car affects the budget line.
  c)Bearing in mind the news story, show the new equilibrium by drawing an indifference curve tangent to the new budget line.
  d)What has happened to the quantity of leased cars purchased? Explain in terms of the income and substitution effects.
Source Earle Eldridge, "Fewer drivers leasing autos," USA Today, July 27, 1999.

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