Tuesday, May 06, 2008

Repeat After Me: No Free Lunch

There is no such thing as a free lunch, promised by a politician or a firm. Chrysler plans on offering customers the chance to cap their gas prices to $2.99 for the next 3 years:

Chrysler also announced an offer that caps the price of gasoline at $2.99 a gallon for three years for people who buy or lease new vehicles from Wednesday through June 2. The offer is based on 12,000 miles of driving per year at the vehicle's rated fuel economy.

Customers will get a card for buying gas that is linked to their own charge account, Chrysler said. The customer will be billed $2.99 a gallon, and Chrysler will pay the rest.

Actual savings depend on what happens to gas prices over the next three years, but based on the $3.61 a gallon average price reported Monday by AAA, someone buying a 2008 Chrysler PT Cruiser, which gets an estimated 21 miles per gallon in city driving, would save $355 a year.

Lets say you believe the weighted average of gas prices over the next 36,000 miles of 3 years to remain at $3.61 and you get that $355 in savings for each of the next 3 years. At a 5% discount rate, that is $967 in net present value. We can safely assume then that demand will push the price of a Chrysler buy or lease up around $1,000. However, applying the Winner's Curse from game theory, those who most overestimate the price of future gas prices will be the ones making the actual purchases by out-bidding all others, meaning they will likely pay more up-front than those who would just pay the market gas prices over the next 3 years.

I hope Chrysler customers will be allowed to put their cards up on e-Bay, this would be fun to watch unfold over the next three years.

1 comment:

Bob said...

Nice. David Ricardo lives!