Freedomnomics: Why the Free Market Works and Other Half-Baked Theories Don't

lemon, a potential buyer assumes that it is. He assumes that the seller has some information about the car that he, the buyer, does not have—and the seller is punished for this assumed information.
And if the car is a lemon? The seller would do well to wait a year to sell it. By then, the suspicion of lemonness will have faded; by then, some people will be selling their perfectly good year-old cars, and the lemon can blend in with them, likely selling for more than it is truly worth.
—Freakonomics37
Nice story—except that it’s wrong. In fact, the widespread perception that a new car loses substantial value as soon as a buyer drives it off the lot is really just a myth, as we shall see.
In a market economy, if anomalies like the well-known lemon problem described by Levitt and Dubner occur, they inevitably create a financial incentive for entrepreneurs to solve them.38 Suppose you buy a car for $20,000 and decide for whatever reason to resell it quickly. Assuming nothing is wrong with the car, you have a $20,000 car with just a few miles on it, but according to Levitt and Dubner you can only sell it for $15,000 because buyers believe that people only try to sell a new car so quickly when there’s something seriously wrong with it. What do you do? Do you really sell the car for a $5,000 loss?
Here is the real question: can you convince someone for, let’s say, $4,000 that there is nothing wrong with your car? What about for $500? Could you hire the car’s original manufacturer to inspect the car and certify that it’s in brand new condition? If you could do this for $500, and inform potential buyers about the certification in your advertisements, you could likely sell the car for the full $20,000, earning for yourself $19,500—not $15,000.
There are, in fact, lots of other possible solutions. For example, car manufacturers also allow warrantees to be transferred to new owners. Whether the warrantee is for three years/36,000 miles or five years/60,000 miles, a person who buys a lemon will not be stuck with it, even if he is the second owner. Furthermore, some places allow you to return a used car for a full refund. For instance, CarSense, a certified used car dealer in the Philadelphia area, offers full refunds for cars returned within five days of purchase.39 And of course, these resale companies want to maintain a reputation for screening out any problematic cars.
Luckily for us, the lemon thesis can easily be tested. I analyzed the prices of fifty-five certified used cars—all 2006 models—in the Philadelphia area, comparing the manufacturers’ suggested retail price (MSRP) for brand new cars with the certified used price and the Kelly Bluebook price.40 The Kelly Bluebook price “reflects a vehicle’s actual selling price and is based on tens of thousands of recent real sales transactions from auto dealers across the United States.”41 I looked at forty used cars that were less than a year old, all with about 15,000 miles on them. These were chosen to divine what used cars sell for when they are about a year old. An additional fifteen used cars had been driven less than 5,000 miles on them, averaging 3,340 miles.
One thing immediately became clear: used cars with only a few thousand miles on them sell for almost the same price as when new. (See table on pages 38-39.) The certified used car price was on average just 3 percent less than the new car MSRP. And it was 3 percent higher than the new car Bluebook prices. The Kelly Bluebook further indicates that the private-transaction used car price was only 4 percent less than the new car Bluebook prices.42 One explanation for such a small discount on private transactions—in which buyers can’t even rely on a brand name dealer’s certification—is that manufacturer warrantees still protect buyers.
I called Kelly Bluebook to check if the sample I had was representative and was told that a study of all the cars in their sample would have yielded a similar result; there is surely no 25 percent drop in a car’s price as soon as you drive it off the lot. Even more damning, the price of these virtually new cars occasionally rises even above the MSRP. The Kelly Bluebook representatives claim that in order to maintain strong resale price values and prevent customers from feeling as if the dealer is taking advantage of them, manufacturers often ensure that dealers cannot sell their cars—even the most popular models—at more than the MSRP.
If the lemon thesis had been correct and “the seller would do well to wait a year to sell it,” as Levitt and Dubner claim, then used cars that are about a year old should not sell for much less than those with only a few thousand miles on them. But, indeed, they do sell for a lot less. Cars that are a year old have substantially lower prices. The certified used car price for these older cars was 14 percent lower than the new car MSRP and 8 percent lower than the new car Bluebook prices.
Are Real Estate Agents Really Like Klansmen?
Agents are often better informed than the clients who hire them and may exploit this informational advantage. Real estate agents, who know much more about the housing market than the typical homeowner, are one example. Because real estate agents receive only a small share of the incremental profit when a house sells for a higher value, there is an incentive for them to convince their clients to sell their houses too cheaply and too quickly... we find homes owned by real estate agents sell for about 3.7 percent more than other houses and stay on the market about 9.5 days longer, even after controlling for a wide range of housing characteristics.
—Steven Levitt and Chad Syverson43
Do Car Prices Plummet as Soon as They Leave the Show Room? Looking at Used Cars Being Sold with