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Solution for Managerial Economics 4th Edition Chapter 19, Problem 1

by Luke M. Froeb, Brian T. McCann, Michael R. Ward, Mike Shor
147 Solutions 23 Chapters 104010 Studied ISBN: 9781305259331 Economics 5 (1)

Chapter 19, Problem 1 : 19-1 Leasing Residuals In the late...

19-1 Leasing Residuals

In the late 1990s, car leasing was very popular in ty1y15he United States. A customer would lease a car from the manufacturer for a set term, usually two years, and then have the option of keeping the car. If the customer decided to keep the car, the customer would pay a price to the manufacturer, the residual value,computed as 60% of the new car price. The manufacturer would then sell the returned cars at auction. In 1999, the manufacturer lost an average of $480 on each returned car (the auction price was, on average, $480 less than the residual value).

a.Why was the manufacturer losing money on this program?

b.What should the manufacturer do to stop losing money?

Step-By-Step Solution

19-1 a.Adverse selection [not necessary to use the jargon].  Customers are keeping the good cars (those worth more than the residual value) and returning the bad cars (those worth less than the residual value).

b.Set a more accurate residual value.  The company hired an appraiser to set the residual value two weeks before the car was returned.  By setting a more accurate residual value (closer to the car’s value), most consumers were indifferent between returning and keeping their cars.  The value of the returned cars was very close to the auction price.

 

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