Tuesday, October 4, 2011

Left-Number Bias in Used Car Prices

Left-number bias is when you pay disproportionate attention to the number on the left. It's the reason why you see so many more prices at, say, \$69.99 than at \$70.01. When buying a used car, left-number bias manifests itself on the odometer: that is, car buyers view the difference between, say, 67,000 and 68,000 miles as of only modest importance, but the difference between 69,000 and 70,000 miles as quite important. Nicola Lacetera, Devin Pope, and Justin Sydnor Heuristic explore this topic with a with a data set of 22 million used car transations in "Heuristic Thinking and Limited Attention in the Car Market." It's NBER Working Paper No. 17030, but these papers are gated unless your institution has a membership.

For a short overview of the paper in the NBER Digest by Lester Picker, see here. I quote from that overview: "[T]he authors document significant price drops at each 10,000-mile threshold from 10,000 to 100,000 miles, ranging from about \$150 to \$200. For example, cars with odometer values between 79,900 and 79,999 miles, on average, are sold for approximately \$210 more than cars with odometer values between 80,000 and 80,100 miles, but for only \$10 less than cars with odometer readings between 79,800 and 79,899. The authors also find price drops at 1,000-mile thresholds, but these changes are smaller."

Here is an illustrative figure. the horizontal axis shows miles on the odometer of the used car, rounded down to the nearest 500. The vertical axis shows average sale price. As you would expect, cars with more mileage on average sell for less. But look at what happens at each 10,000-mile level. Instead of price dropping in a more-or-less smooth line, there is a discrete price drop at each 10,000 mile level, showing the left-number bias at work.

Picker's overview in the NBER Digest also says: "This apparent left-digit bias not only influences wholesale prices but also affects supply decisions. If sellers are savvy and are aware of these effects, then they will have an incentive to bring cars to auction before the vehicle's mileage crosses a threshold. Indeed, the authors show that there are large volume spikes in cars before 10,000-mile thresholds."

Here's a figure showing this effect on the supply side.Again, the horizontal axis shows mileage on the odometers of used cars. This time, the vertical axis shows volume of cars sold with that mileage. As one would expect, relatively few cars are sold with extremely low mileage. But look at the line at the 10,000-mile intervals from 60,000 to 100,000. There is an extra little blip of more cars being sold just before they cross over into the next mileage category. This is smart sellers, taking advantage of the left-number bias on the part of buyers.