Participants in Europe''s biggest online market for cars put too much weight on the registration year of a vehicle and partly ignore the valuable information of the registration month. That is the central finding of research by Till Stowasser and colleagues, to be presented at the Royal Economic Society''s annual conference at the University of Bristol in April 2017.
Their study documents strong ''price discontinuities'' at registration-year changes: the price differential between two cars across registration years (where one car was first registered in January and the other in December of the previous year) is up to four times larger than that between two cars first registered in any two subsequent months within the same registration year. In fact, nearly a third of the annual overall depreciation of a generic car occurs when moving to January from December of the previous year.
These indications of price discontinuities because of the limits of consumer rationality are likely to apply in other markets where individuals base their decisions on continuous parameters that are mapped into discrete categories. Examples include financial products (ratings), real estate (living space), computers (processor speed) or food (sugar content).
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Our paper (which is forthcoming in Management Science) adds to the growing research literature documenting that even in the presence of almost perfect information, humans make poor decisions because their rationality and mental capacity are bounded – or put differently because they are human.
We study price-setting behaviour in a competitive market for high-value durable consumption goods: the German marketplace mobile.de, Europe''s largest online market for used cars.
In line with preconceptions of Prussian ''methodicalness'', cars in Germany have an official and legally mandated documentation record that makes the year and the month of first registration verifiable information. This ''birth date'' is one of the most salient and important car features and is also available at no cost to buyers and sellers on mobile.de.
As expected, we find that a car''s price decreases with its age. But we document strong discontinuities in prices at registration-year changes: the price differential between two cars across registration years (where one car was first registered in January and the other in December of the previous year) is up to four times larger than that between two cars first registered in any two subsequent months within the same registration year. In fact, roughly 32% of the annual overall depreciation of a generic car occurs when moving from January to December of the previous year.
This pattern suggests that consumers fail to process information efficiently (even if available at no cost) and instead rely on heuristic evaluation rules that are compatible with a model of limited attention: they put too much weight on the registration year and partly ignore the valuable information of the registration month.
Such an inattention model is readily applicable to a wide set of domains where individuals base their decisions on continuous parameters that are mapped into discrete categories and for which inefficient price discontinuities might also exist, such as financial products (ratings), real estate (living space), computers (processor speed) or food (sugar content).
Our research has important managerial implications for optimal product design, implying that endogenous product features should strategically stay below (sugar content of a beverage) or above (living space of a new construction) salient thresholds. In case of exogenous product features, attention needs to be devoted to making the ''right'' features salient.
Another relevant question concerns the welfare implications of the price discontinuities in the used-car market that we investigate. Given that a substantial amount of cars will be overpriced relative to their objective characteristics, there will be redistributive effects to the detriment of inattentive buyers.
At the same time, it is possible that overpricing leads to too little trade and a real loss in surplus, as overly expensive vehicles may be shunned by rational buyers, causing a welfare loss among market participants who fail to sell their prohibitively priced January cars.
While these inefficiencies make the case for the elimination of price discontinuities, it is not clear that marketplace providers would favour such action, too. Sellers (who are the ones paying for the service offered by the marketplace) might prefer market segmentation because their products will appear more differentiated than they really are, thereby weakening competition.
Price Discontinuities in an Online Market for Used Cars – Florian Englmaier (University of Munich), Arno Schmöller (TWS Partners) and Till Stowasser (University of Munich)
