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Why was the manufacturer losing money on program

Assignment Help Macroeconomics
Reference no: EM133202750

Problem:

In the late 1990s, car leasing was very popular in the 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.)

  • Why was the manufacturer losing money on this program? Was this a problem of adverse selection or moral hazard?
  • What should the manufacturer do to stop losing money? Will rational actors use rules of thumb?

Reference no: EM133202750

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