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Sunday, August 9, 2009

Cash for Clunkers Economics

How much is the "Cash for Clunkers" program actually saving (costing)?

Suppose you drive 10,000 miles per year. You trade in an old car that gets 20 miles per gallon and buy a new car that gets 30 miles per gallon.

Your gasoline consumption decreases from 500 gallons per year to 333 gallons per year.

Assuming that gasoline costs $5/gallon, this is a net savings of $835 per year. If I make more charitable assumptions and assume that the new car gets 40 miles per gallon, then the net savings is 250 gallons per year or $1250. If you drive 20,000 miles per year instead of 10,000, then the savings is 500 gallons per year.

A new car costs approximately $15000. Translating from $ to energy, the new car costs the equivalent of 3000 gallons of gasoline.

Obviously, this is a net losing proposition.

If you include the energy cost of building a new car and scrapping the old one, the "Cash for Clunkers" program is obviously one big "broken window" fallacy. Literally, the State is paying people to destroy their own property.

Overall, wealth is being destroyed by the "Cash for Clunkers" program. Executives at car manufacturing businesses profit, while everyone else pays the cost via inflation.

I realized another defect in the above reasoning. Supposed your used car is worth $2k and you get the "Cash for Clunkers" credit of $4500. In that case, your State subsidy is not $4500 but rather $2500. The State is buying your car for $2000, paying you an extra $2500, and then trashing your car.

There's another interesting side effect of "Cash for Clunkers". It's hurting the used car market. Suppose you were trying to buy a used car for $2000. The inventory of used cars is being depleted, because cars are being destroyed for the $4500 credit.

The "Cash for Clunkers" program hurts people who were trying to buy a cheap used car.

1 comment:

fritz said...

I am wondering if they sell the cars you trade in or scrap them. I would imagine they are sold at the car auction and if so they would just end up on the streets again.


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