Computing equilibria in the market for automobiles

Line of cars

4 minute read

An economics expert from The Australian National University (ANU), Professor Fedor Ishakov, has developed a dynamic model of trading in new and used cars that uses a novel fast and robust algorithm for computing equilibria – a situation in which supply and demand are matched and prices are stable.

Fedor’s co-authored paper Equilibrium Trade in Automobiles, which proposes the model and algorithm, has been accepted for publication in the Journal of Political Economy (JPE), a journal that sits among the top five economics journals in the world.

“I feel very pleased and honoured to have our work accepted for publication by a top-tier international journal,” says Fedor, who is from the ANU College of Business and Economics, Research School of Economics.

Professor Kenneth Gillingham of Yale University, Assistant Professor Anders Munk-Nielsen of University of Copenhagen, Professor John Rust of Georgetown University and Professor Bertel Schjerning, also of University of Copenhagen, are co-authors.

“It’s great to know that the product of several years of our hard work will receive the global attention of economic scholars,” Fedor says.

Similar to other durable goods, modelling the automobile market is challenging because trading and substitution possibilities exist due to the presence of a secondary market where used cars are traded. The sheer number of available choices presents a serious computational challenge.

“Not only are there dozens or even hundreds of different makes and models of new cars to choose from in the primary market, consumers have a huge array of used car options as well,” says Fedor.

The novel algorithm and fast computation methods developed by Fedor and his research collaborators improve researchers’ capabilities for modelling and analysing the markets of durable goods, by enabling them to take into account the response of the secondary markets, which is currently usually assumed away. This in turn enables the development of better targeted regulatory policies to affect the equilibrium outcome for the benefit of the society.

Using their method, Fedor’s team were able to utilise almost 39 million observations on car ownership transition from Denmark, to estimate the equilibrium in new and used car markets. They then used their dynamic model to analyse the fiscal and welfare effects – the pros and cons of financial gains or losses and the wellbeing of society – of the significant redistribution of the tax burden from the new car registration tax in Denmark (currently one of the highest in the world) towards car usage taxes such as fuel tax.

In their findings, Fedor’s team could identify the policy that not only increases the total tax revenue in Denmark, but also reduces CO2 emissions and increases aggregate welfare. Implementing such policy would mean increased financial benefits to government as well as a positive impact on the wellbeing of society.

“The main contribution of our research is the development of the methodological and computational framework, which makes it possible to analyse the not-yet implemented policies within the modelling framework that had been considered intractable before,” Fedor says.

Denmark’s automobile market is the subject of Fedor’s research paper, but the work’s greater benefits lie in its ability to be used to analyse any market of durable goods in any country.

According to Fedor, their dynamic-equilibrium framework allows for the development of policies that could shift the equilibrium of durable goods trading in many other secondary markets towards more beneficial outcomes.

“For example, book publishers tend to limit second-hand trading of textbooks by regularly producing slightly different updated editions. What does this mean from an ethical point of view? Our framework can be applied to model this market and find policies to improve public welfare,” he says.

Fedor and his research collaborators have plans to continue their work with studying the competition on the primary market in presence of the active secondary market, adoption of new technologies such as electric cars, and other extensions.

“We believe that our framework is promising for empirical applications and policy analysis, and in our future work we plan to extend and apply it in a number of directions,” shares Fedor.

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