It may be a good time to buy a car

Given that my ECONS101 students have their final exam next week, a post on supply and demand seems timely. Let's consider this New Zealand Herald article from last week:

In a twist of irony, now might be the best time to buy a new car.

As rising fuel prices burn Kiwi wallets, the Vehicle Industry Association (VIA) has released a statement saying a glut of imported cars has created excessive supply, pushing down retail prices.

Consider the market for second-hand cars in New Zealand, as shown in the diagram below. Initially, the market is at equilibrium, where the demand curve D0 meets the supply curve S0. The equilibrium price is P0 and the equilibrium quantity is Q0.

Then, there is an increase in supply (from S0 to S1). The article mentions that this is because:

"The stink bug disrupted car importing for a lot of dealers earlier this year and left them waiting longer than usual for stock while vehicles were treated for the pest and held up at our borders," [Trade Me spokesperson Millie] Silvester said.

"Now this backlog has cleared and so as a result we've seen a flood of vehicles come onto site."

At the same time, there has probably been a decrease in demand. Why? Petrol and cars [*] are complements. If you have a car, it needs petrol. The petrol price has been increasing recently. Consumers will respond by demanding less petrol, and by looking for alternatives to cars, so the demand for cars will reduce (from D0 to D1 on the diagram).

At the original equilibrium price of cars, there is now excess supply, or a surplus (the quantity supplied (QS) is greater than the quantity demanded (QD)) - sellers can't sell all of the cars they have at that high price. You can expect the price of cars to fall (eventually settling at the new equilibrium price, P1). So, it might be a good time to buy a car.

What has happened to the quantity of cars traded? When we know there is a decrease in demand and an increase in supply, we can be sure the equilibrium price will decrease, but the change in equilibrium quantity is ambiguous, because it depends on the relative size of the shifts in supply and demand (if supply has increased by more than the decrease in demand, the equilibrium quantity will increase; but if demand has decreased by more than the increase in supply, the equilibrium quantity will decrease). In this case, the increase in supply seems to be larger than the decrease in demand, because the article notes that:

"Retail car sales (including imports) have been tracking well for us. In fact, we just had our best ever retail volume month and we are very confident as we come into the summer months which are normally quite buoyant for our business," [Turners chief executive Greg] Hedgepeth said.

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[*] At least, petrol and petrol-powered cars are complements. Electric cars will be substitutes for petrol and petrol-powered cars, but they are still only a small share of the market.