Staff Report, Federal Reserve Bank of New York 394
This paper presents a dynamic model for light motor vehicles. Consumers solve an optimal stopping problem in deciding if they want a new automobile and when in the model year to purchase it. This dynamic approach allows for determining how the mix of consumers evolves over the model year and for measuring consumers' substitution patterns across products and time. I find that temporal substitution is significant, driving consumers' entry into and exit from the market. Through counterfactuals, I show that because consumers will temporarily substitute to a large degree, failure to account for automakers' dynamic pricing strategies results in an inaccurate picture of the return to using pricing incentives. A further finding is that the large price discounts typically offered at the end of the model year result in price discrimination by inducing price-sensitive consumers to delay purchasing new vehicles until the later months of the model year.