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  , D.C.
  Incentives and Prices for Motor Vehicles: What has been happening in recent years?
  Carol Corrado, Wendy Dunn, and Maria Otoo
  2006-09.
  Incentives and Prices for Motor Vehicles: What has been happening in recent years?
  Carol Corrado, Wendy Dunn, and Maria Otoo* Federal Reserve Board Washington, D.C. June 2003 (Revised, January 2006)
  * We thank Marie Degregorio and Matthew Wilson for their assistance; Robert Schnorbus and Matthew Racho at J.D. Power and Associates for helping us with the data; and Mark Bils, Darrel Cohen, Erwin Diewert, Charles Gilbert, Kathleen Johnson, and Jeremy Rudd for helpful discussions. The views expressed in this paper are those of the authors and should not be attributed to the Board of Governors of the Federal Reserve System or other members of its staff..
  Incentives and Prices for Motor Vehicles: What has been happening in recent years? Carol Corrado, Wendy Dunn, and Maria Otoo January 2006.
  KEYWORDS: Price indexes, motor vehicles, motor-vehicle financing. Carol Corrado Wendy Dunn Maria Otoo Stop 82 Division of Research and Statistics Federal Reserve Board Washington, D.C. 20551
  2 model-year.
  3
  Pashigian, Bowen, and Gould (1995) showed that the behavior of the not seasonally adjusted car price data in the CPI accords well with what theory would predict for the behavior of prices of a “fashion” good. Price drops for fashion goods over a selling period are regarded as seasonal phenomena. Not all of the price drops for vehicles in the CPI sample are treated as seasonal phenomena; indeed, a portion is treated in what Bils (2004) regards as the appropriate way. 2 PIN collects data in a number of U.S. markets and in Canada. The U.S. geographic markets as of late 2003 were Boston, New York, Philadelphia, Pittsburgh, Baltimore/Washington DC, Charlotte, Atlanta, Orlando, Tampa, Miami, Houston, Dallas/Fort Worth, Tulsa/Oklahoma City, St. Louis, Indianapolis, Cleveland, Memphis/Nashville, Chicago, Detroit, Minneapolis/St. Paul, Denver, Phoenix, Los Angeles/San Diego, San Francisco/Sacramento, and Seattle/Tacoma/Portland.
  1
  4 roughly one-third-level.
  By manufacturer, the coverage ranges from roughly 15 percent to 25 percent. For example, for leased transactions, PIN calculates an internal rate of return based on the discounted future cash flows associated with the purchase; cash flows for leases include the residual value, monthly payments, and fees such as points, application costs, and security deposits. This calculation results in a rate that is comparable to the interest rate paid on (financed) purchased vehicles (the annual percentage rate, or APR, as defined in the Federal Reserve Board’s Regulation Z).
  4
  3
  5
  As noted in JPDA’s Pin Explorer Glossary, when a trade-in is involved in a transaction, the actual price of the vehicle can be masked from the customer. Two identically-equipped vehicles can be sold at the same underlying price to two customers, yet the prices printed on the customers’ contracts can appear very different. 6 For further details on the measures in the PIN database, see PIN Explorer Glossary, J. D. Power and Associates (2003). 7 A limitation of the data is that PIN Explorer records no information on service contracts that are given away. When a service contract is purchased at a reduced price, however, the value of the contract will appear in PIN along with other related information.
  5
  6-based prices will reflect the actual monthly variation in the size and incidence of incentives shown in charts 1 and 2. We thus believe that the PIN vehicle price less the cash rebate is a highly accurate measure. Indeed, the adjustment for tradeconsumer
  To estimate the CPI for new motor vehicles, the BLS begins with the vehicle’s sticker price. It then adjusts the sticker price to arrive at a transactions price. According to the BLS Handbook of Methods (page 29), “When pricing new vehicles, BLS economic assistants obtain separately all the components of the sticker price. This includes the base price and the price for options, dealer preparation, transportation, etc.” Since 1998, the CPI has excluded the line item, “automobile finance charges,” which was separate from the index for new vehicles. 9 The calculation is based on incentive programs offered by the six largest-selling manufacturers in the United States: General Motors, Ford, Chrysler, Toyota, Honda, and Nissan.
  8
  7month
  For ease of exposition, we will omit references to lease transactions in the discussion that follows. Of course, the subvention estimates we develop fully capture the effects of lease promotions (“no down payment”, “no lease-end fees”, and so on) if such promotions actually lower the lessor’s implied rate of return on a lease transaction. 11 Nonetheless, if independent financing through dealerships is a significant source of interest subvention, our measure will overstate the manufacturer-to-consumer concept that we want. We believe this possibility to be highly unlikely, however. When a customer fills out a loan application at a dealership, often the dealership submits the application to a number of lenders. If an independent lender accepts the customer’s loan application, a wholesale rate is quoted to the dealership. The dealership may then quote a higher rate to the customer, and this rate becomes the observed retail rate (if the transaction is consummated). The spread between wholesale and retail rates has traditionally been an important source of dealership revenue.
  10
  8-weighted mean (44-1/2 years), the alternative rate was increased 0.05 percentage point for each year below the mean. Thus, a model with a mean customer age of 18 years would have an alternative interest rate roughly 1-1/4 percentage points higher than would a model with a mean customer age of 44-1
  Note that the coefficients on income and wages are insignificant when home ownership and educational attainment are included in the regressions.
  12
  9level observations available in PIN. We use the model year 2002 for illustration. In the Ward’s data, 16 models accounted for the top one-third of all light vehicle sales. The middle one-third
  The coefficient estimates in column 4 changed little when the home ownership and educational attainment variables were added to the regression.
  13
  10-weighted  2-1/2 percent per year. Excluding incentives, the ASP of vehicles rose 3-1
  The second limitation refers to the data from PIN Explorer that are available to us; this is not an inherent limitation of the information collected by JPDA for inclusion in PIN. 15 This differential does not necessarily reflect an increase in the loan-to-value ratio. Consumers may chose to finance sales taxes and the F&I products (service contracts, insurance) or additional items (fabric protector, paint sealants) purchased from the dealership, and the prices (or quantities) of these items may have increased more than the vehicle price during this period.
  14 model-year.
  The database that we construct from the raw PIN data uses 490 PIN models rather than the 506 PIN models available to us because of the need to drop 16 models with missing or problematic observations. The dropped models account for an extremely small, negligible portion of total sales. 17 A platform is the basic structure of a vehicle; we used Ward’s data on vehicle platforms by model year to identify models that had been through major redesigns. For PIN models more disaggregate than Ward’s models, we used information from Internet sources (new vehicle reviews and summary articles on vehicle redesigns) to make the identification. We also used Internet sources to verify the accuracy of trim change counts for models with two or more name changes.
  16
  12
  13frequencyaverage sales in July and August and average or slightly below-average sales in September and October. Factors for the late 1970s for these months expected sales to be substantially aboveaveragemodel:
  These different production and spending patterns by model year show through in the composition and age of dealers’ inventory by model year. The automaker’s inventory control problem and its implications for manufacturers’ pricing decisions are explored in Copeland, Dunn, and Hall (2005). 19 We wish to thank our colleague Dan Vine for pointing us in this direction.
  18
  14 ln Pt − ln Pt − 1 = ∑ j∈ M t / t −1 sj , t (ln Pj , t − ln Pj , t − 1), (1)
  where
  sj , t = 1 / 2 ⎡ PQj , t / ∑ j∈ M t / t −1 PQj , t + PQj .t − 1 / ∑ j∈ M t / t −1 PQj .t − 1⎤ ⎣ ⎦
  t = 1,....T
  Summation over matched models is denoted as
  ∑
  j∈ M t / t −1
  , where Mt is the set of unique goods
  produced or sold in each period and Mt/t-1, (that is, Mt ∩ Mt-1) is the set of goods produced or sold in adjacent periods. When the results of (1), as well as those of the closely related Fisher formula, are chained together over T periods, the price index is exact for periods before and after changes in the composition of Mt/t Mt/tquarter
  15
  16
  17month 3-1.
  Indeed, indexes calculated under the third matching assumption are equivalent to indexes calculated using modelyear expenditure shares (previously shown in chart 4) to aggregate the model-year matched-model price indexes (previously shown in chart 5) according to equation (1).
  20
  18 One could also argue, however, that because of the interaction between new and used vehicle markets, and because the model year is an easily observable product characteristic that is strongly correlated with the age of a vehicle, the treatment of all model-year
  Obsolescence is defined as the decline in the price of a newly produced asset (or a price index for a cohort of assets) in the presence of a new vintage of the asset, a definition and terminology drawn from the literature on economic depreciation. See Diewert (2005) for a recent review of this literature.
  21
  19
  These changes, which are shown in the middle panel of the table, were calculated from the data on ASPs in dollars (shown on table 5). 23 At regular sample rotations, the BLS draws a new sample of stores and products within a geographic area to better reflect current consumer spending. Bils (2004) refers to these as scheduled substitutions. Forced substitutions occur when a store stops selling a particular product that is being priced, and the BLS agent substitutes another model of that brand or of a similar product.
  22
  20.
  21 References.
  22. 137-96.Season Decline in Automobile Prices,” Journal of Law and Economics, vol. 38 (October), pp. 281-309. Triplett, Jack E. (1969). “Automobiles and Hedonic Quality Measurement,” Journal of Political Economy, vol. 77 (May-June), pp. 408-17.
  23
  Table 1. Definition of Selected Variables in PIN Explorer Variable Vehicle price Definition The price that a customer pays for a vehicle and for factory and dealerinstalled accessories and options, adjusted for the trade-in allowance. (The trade-in allowance is the difference, if any, between the amounts a dealer allows a customer for a trade-in and the wholesale market-value of the trade-in.) The vehicle price excludes the price of aftermarket options, fees, taxes, or service contracts. The price after manufacturer-to-consumer rebates. The customer cash rebate, the cash amount given to the customer, is subtracted from vehicle price. The annualized percentage rate (APR) paid by a customer on a financed or leased vehicle. For finance transactions, the APR is as defined in the Federal Reserve Board’s Regulation Z. For leased transactions, PIN calculates an internal rate of return (IRR) that is comparable to the APR. The number of months that a customer will make finance or lease payments on a vehicle. The portion of the total purchase price (including the cost of finance and insurance products) that is funded by a lender or lessor. Applies only to finance and lease transactions. The age of the customer at the time of purchase or lease.
  Vehicle price less customer cash rebate Interest rate (APR/IRR rate)
  Term Amount financed
  Customer age
  Note: Includes purchased and leased vehicles. Source: PIN Explorer Glossary , J.D. Power and Associates (2003).
  24
  Table 2. Interest Rates on New Vehicle Loans and the Average Age and Income of Buyers Age of respondent (years) Mean Interest rate (percent) Total household income 1 Household wage income1 21-29 11.2 48 45 30-39 10.2 108 97 40-49 9.4 142 81 50-59 9.1 603 101 60-69 8.9 494 72 70 and over 7.2 71 21
  Note: In thousands of current dollars; reflects income in 2000; number of observations is 686. Source: Survey of Consumer Finances , 2001, Board of Governors of the Federal Reserve System.
  25
  Table 3. Factors Affecting Interest Rates on New Vehicle Loans, Selected Results, 1999-2001 Dependent variable: interest rate on new vehicle loans Age Annual household income Annual wages and salaries Home ownership Educational attainment Lending source: Captive finance companies Credit unions Finance companies -2.32 (0.16) -1.15 (0.18) (1) -0.05 (0.01) (2) -0.02 (0.01) -0.08 (0.50) (3) -0.02 (0.01) (4) -0.05 (0.01)
  -0.11 (0.38) -2.32 (0.16) -1.18 (0.18) -1.28 (0.52) -1.09 (0.45) 1.53 (0.41).
  26
  Table 4. Examples of Model-Level Detail and Nomenclature in PIN Explorer Manufacturer General Motors BMW Group Ford DaimlerChrysler Nameplate Buick BMW Mercury Mercedes-Benz Model LeSabre 325xi Sable ML320 Trim level LeSabre Limited n.a. Sable GS n.a. Model year 2001 2003 2000 1998
  Source: J.D. Power and Associates. n.a. Not available.
  27
  Table 5. Average Value of Consumer Vehicle Incentives and Prices (dollars), 1999-2003 Average Value of incentives Cash rebates Interest subvention Actual price Car Truck Price after cash rebate Car Truck Price before incentives Car Truck Memo: Customer age (years) Loan term (months) Interest rate (percent) Amount financed 1,421 689 733 24,024 22,318 25,619 24,757 22,936 26,460 25,445 23,491 27,268 44.4 53.4 6.9 23,508 1999 803 339 464 23,312 21,853 24,740 23,776 22,275 25,256 24,115 22,633 25,565 43.1 49.9 7.8 22,162 2000 1,111 402 709 23,540 22,147 25,031 24,249 22,742 25,868 24,651 23,089 26,332 43.4 51.1 8.2 22,803 2001 1,398 508 890 23,926 22,268 25,502 24,816 22,998 26,547 25,324 23,421 27,149 44.5 53.2 6.9 23,339 2002 1,627 842 785 24,469 22,665 26,074 25,254 23,314 26,978 26,096 23,937 28,015 45.2 55.2 6.3 24,232 2003 2,168 1,352 816 24,873 22,655 26,749 25,689 23,351 27,653 27,041 24,376 29,278 45.7 57.4 5.4 25,004
  Note: All items are sales-weighted. Source: Authors’ estimates based on information from J.D. Power and Associates’ PIN Explorer database.
  28
  Table 6. PIN Models by Model Year, 1998-2004 Continuing models Model year 1998 1999 2000 2001 2002 2003 2004 Total, all years
  1
  Total number models 259 273 280 306 322 324 335 506
  New models 21 28 35 59 40 42 46 271
  1
  Total 238 245 245 247 282 282 289 B
  Major re-designs 16 18 18 17 13 15 15 112
  New trims n.a. n.a. 53 74 79 70 58 B
  2
  Memo: Ward’s AutoInfo Databank 256 253 266 276 279 295 304 400).
  29
  Table 7. Number of Continuing Models by Model Year, average monthly rate per quarter, 1998:Q4 - 2003:Q4 Model Year 1998 1999 2000 2001 2002 2003 2004 Total Continuing Entering Exiting Total marketed 375 30 16 406 378 4 17 383 315 5 26 320 316 57 16 373 420 19 17 438 405 9 17 414 352 7 29 359 354 64 19 418 462 17 20 479 442 7 16 449 398 7 23 404 393 71 25 464 533 21 18 554 480 5 30 485 418 9 28 427 406 67 25 474 509 20 25 529 98Q4 99Q1 99Q2 99Q3 99Q4 00Q1 00Q2 00Q3 00Q4 01Q1 01Q2 01Q3 01Q4 02Q1 02Q2 02Q3 02Q4 03Q1 03Q2 03Q3 03Q4 176 200 127 246 6 53 248 14 13 238 64 199 220 149 252 4 73 259 20 18 249 87 211 251 163 278 100 285 13 40 273 80 9 250 274 3 173 301 4 2 96 303 18 2 31 289 85 1 2 244 261 165 299 3 467 9 26 476 98 303 25 427 12 26 439 39 293 102 434 63 23 497 6 262 274 542 25 21 567.
  30
  Table 8. Model-year Price Indexes by Price Concept and Nameplate (percent change over the model year, annualized) Model year of index Average Actual price Big Three nameplates Large Japanese nameplates Other nameplates Price after cash rebate Big Three nameplates Large Japanese nameplates Other nameplates Price before incentives Big Three nameplates Large Japanese nameplates Other nameplates -6.1 -7.0 -5.2 -5.2 -4.7 -5.2 -4.0 -4.8 -2.4 -1.6 -3.2 -3.8 1999 -4.1 -4.8 -2.7 -4.4 -4.2 -4.9 -2.2 -4.8 -2.5 -2.5 -1.5 -3.9 2000 -5.2 -6.8 -3.6 -3.1 -3.3 -3.6 -3.6 -3.1 -1.9 -1.4 -3.1 -2.5 2001 -6.8 -8.3 -5.8 -4.6 -3.6 -3.9 -4.0 -3.5 -2.7 -2.4 -3.2 -2.8 2002 -6.0 -5.5 -6.7 -6.2 -4.4 -4.4 -4.6 -5.2 -2.3 -1.0 -3.9 -4.5 2003 -8.4 -9.4 -7.0 -7.6 -7.9 -9.1 -5.6 -7.6 -2.7 -0.9 -4.3 -5.2
  Effect of incentives (percentage points) Both incentives (actual price less price before incentives) Big Three nameplates Large Japanese nameplates Other nameplates Cash rebate (price after rebate less price before) Big Three nameplates Large Japanese nameplates Other nameplates Interest subvention (actual price less price after rebate) Big Three nameplates Large Japanese nameplates Other nameplates 3.7 5.4 2.0 1.4 2.3 3.6 0.8 1.1 1.4 1.8 1.2 0.4 1.7 2.3 1.2 0.5 1.8 2.5 0.7 0.9 0.1 0.2 0.5 0.4 3.3 5.4 0.4 0.6 1.4 2.2 0.4 0.6 1.9 3.2 0.0 0.0 4.1 5.9 2.5 1.8 0.9 1.5 0.7 0.6 3.2 4.4 1.8 1.2 3.7 4.5 2.8 1.7 2.1 3.5 0.7 0.7 1.6 1.1 2.1 1.0 5.7 8.5 2.8 2.5 5.2 8.3 1.3 2.4 0.5 0.3 1.4 0.0
  Note: The changes are from the third quarter of the introductory year to the fourth quarter of the following year. The Big Three refers to General Motors, Ford, and Chrysler. Source: Authors’ estimates based on information from J.D. Power and Associates’ PIN Explorer database.
  31
  Table 9. Model-year Price Indexes by Market Segment (percent change over the model year, annualized)
  Model year of index Average Actual price Car Compact Mid-size Full-size Luxury Sports Truck Pickup SUV Van -6.1 -6.3 -6.5 -6.5 -8.9 -5.6 -6.6 -5.9 -6.0 -5.7 -6.7 1999 -4.1 -4.2 -5.2 -3.5 -6.7 -4.1 -5.0 -4.0 -6.1 -2.7 -5.4 2000 -5.2 -4.9 -4.6 -5.3 -8.5 -3.9 -4.7 -5.5 -4.6 -6.1 -6.3 2001 -6.8 -6.6 -5.6 -7.3 -10.6 -5.3 -8.3 -6.9 -6.4 -6.9 -7.3 2002 -6.0 -7.3 -7.9 -7.2 -9.4 -7.1 -6.3 -4.9 -5.8 -4.9 -4.3 2003 -8.4 -8.7 -9.0 -9.1 -9.5 -7.7 -8.9 -8.2 -7.2 -7.9 -10.0
  Effect of incentives (percentage points) Both incentives Car Compact Mid-size Full-size Luxury Sports Truck Pickup SUV Van 3.7 3.1 4.2 3.8 7.3 0.6 2.7 4.1 4.9 3.9 3.7 1.7 1.8 2.7 2.9 4.6 0.8 0.9 1.5 2.0 1.3 1.5 3.3 2.8 2.5 3.5 8.7 0.3 2.3 3.9 3.7 3.9 4.6 4.1 3.5 3.8 4.5 8.8 1.2 3.8 4.4 5.0 4.3 3.3 3.7 3.1 4.8 2.9 6.1 1.6 2.5 4.0 5.2 4.2 1.5 5.7 4.4 7.3 5.2 8.2 0.8 3.8 6.7 8.7 5.7 7.4
  Note: The changes are from the third quarter of the introductory year to the fourth quarter of the following year. SUV refers to sport utility vehicle. Source: Authors’ estimates based on information from J.D. Power and Associates’ PIN Explorer database.
  32
  Table 10. Model-year Price Indexes by Models Treated as New (percent change over the model year, annualized) Model year of index Average 1999 2000 2001 2002 Actual price -6.1 -4.1 -5.2 -6.8 -6 Entering models, redesigns -6.3 -3.2 -4.4 -6.5 -7.5 Other models -6.1 -4.3 -5.3 -6.9 -5.8 Effect of incentives (percentage points) Both incentives 3.7 1.7 3.3 4.1 3.7 Entering models, redesigns 2.8 1.5 1.8 2.8 3.9 Other models 3.9 1.7 3.6 4.4 3.7
  Note: The changes are from the third quarter of the introductory year to the fourth quarter of the following year. Source: Authors’ estimates based on information from J.D. Power and Associates’ PIN Explorer database.
  2003 -8.4 -9.7 -8.3 5.7 3.9 6.2
  33
  Table 11. Consumer Vehicle Price Indexes, by Price Concept and Models Treated as New (twelve month percent change, December to December) Average 1999 2000 2001 -2.6 -4.2 -6.2 -0.1 -1.6 -3.5 0.2 -1.1 -2.4 1.0 2.7 2.5 2002 -2.2 -4.2 -6.6 -2.4 -3.8 -5.7 0.0 -1.2 -2.5 2.5 1.9 4.1 2003 -1.5 -3.9 -7.7 -2.4 -4.7 -8.0 0.6 -1.0 -3.1 4.9 3.7 5.4
  Actual price Entering models, redesigns -1.2 1.3 -0.9 Entering models, redesigns, new trims -3.3 -1.3 -3.0 All models -5.9 -2.9 -6.1 Price after cash rebate Entering models, redesigns -0.7 0.9 0.6 Entering models, redesigns, new trims -2.6 -1.3 -1.3 All models -4.9 -3.2 -3.9 Price before incentives Entering models, redesigns 0.8 1.5 1.6 Entering models, redesigns, new trims -0.7 -0.1 0.0 All models -2.3 -1.5 -2.1 Percent change in average selling price Actual price Price after cash rebate Price before incentives Actual price Entering models, redesigns Entering models, redesigns, new trims All models Price after cash rebate Entering models, redesigns Entering models, redesigns, new trims All models Price before incentives Entering models, redesigns Entering models, redesigns, new trims All models CPI for new vehicles
  1
  2.5 2.6 3.5
  3.8 3.5 3.7
  0.4 1.4 1.8
  Implied quality change1 3.7 5.8 8.4 3.3 5.2 7.5 2.7 4.2 5.8 -0.9 2.6 5.1 6.8 2.6 4.8 6.7 2.2 3.8 5.1 -0.5 1.4 3.5 6.6 0.8 2.7 5.3 0.2 1.8 3.9 0.0 3.6 5.2 7.2 2.8 4.4 6.3 2.3 3.6 4.8 -0.1 4.7 6.7 9.1 4.3 5.8 7.6 4.0 5.2 6.6 -2.0 6.4 8.8 12.6 6.1 8.3 11.7 4.8 6.4 8.5 -1.9
  Percent change in average selling price less percent change in price index. Source: Authors’ estimates based on information from J.D. Power and Associates’ PIN Explorer Database.
  34
  Chart 1
  Value of Incentives
  Current dollars 1800 1800
  1600
  1600
  Cash rebates
  1400 1400
  1200
  Interest subvention
  1200
  1000
  1000
  800
  800
  600
  600
  400
  400
  200
  1999
  2000
  2001
  2002
  2003
  200
  Constructed using data from J.D. Power and Associates.
  35
  Chart 2
  Sales Penetration of Incentives
  Percent 60 55 50 45 40 35 30 25 60 55 50 45
  Cash rebates
  40 35 30 25
  Interest subvention
  20 15 10 20 15 10
  1999
  2000
  2001
  2002
  2003
  Constructed using data from J.D. Power and Associates.
  36
  Chart 3. Count of Models Sold by Month, 1995-2004
  290
  280
  May 270
  260
  250
  240
  1995
  1996
  1997
  1998
  1999
  2000
  2001
  2002
  2003
  2004
  230
  Source. Ward’s Communications.
  37
  Chart 4. Expenditure Shares by Model Year (percent of total expenditure, March 1998 to December 2003)
  1.2
  1998 model year 1999 model year 2000 model year 2001 model year 2002 model year 2003 model year 2004 model year
  1.2
  1.0
  1.0
  0.8
  0.8
  0.6
  0.6
  0.4
  0.4
  0.2
  0.2
  0.0 July 1998 July 1999 July 2000 July 2001 July 2002 July 2003
  0.0
  Constructed using data from J.D. Power and Associates.
  38
  Chart 5. Matched-model Price Indexes by Model Year
  Price before incentives
  1999 model year 2000 model year
  Price after incentives
  2001 model year 2002 model year 2003 model year 2004 model year
  1.00
  1.00
  0.98 0.96 0.94
  0.98 0.96 0.94
  0.92 0.90
  0.92 0.90
  0.88
  0.88
  1998
  1999
  2000
  2001
  2002
  2003
  Constructed using data from J.D. Power and Associates.