How to Buy a Car: Game Theory Edition
In our extremely mobile society, odds are that you will come into contact with the car-buying process at some point in your life. Whether you’re buying a car by choice or by necessity, no one likes to feel like they were charged too much for an already expensive purchase. This, along with all the other options available to consumers to help them with their purchases, can make car-buying a daunting process. But never fear, Game Theory is here!
This article gives plenty of advice about how to buy a vehicle. A good portion of the recommendations pertain to who knows what in the car-buying scenario. The dealer may know what the buyer is looking for, but it’s best if the dealer doesn’t know the maximum price the buyer is willing to pay or whether the buyer has a trade-in. On the other hand, the buyer should let the dealer know that they have another dealer offering a lower price for the same car in order to give the dealer incentive to lower his price in order to compete. Meanwhile, the dealer will also use his knowledge of extended warranties, dealership loans, and add-ons to make the highest profit. The bottom line is that your profit as a buyer is the difference between the price you pay and the price you can pay, so accepting a price that is outside your budget will result in a net loss (and probably an ugly loan to pay off).
To analyze this problem using Game Theory, we’ll simplify the problem a bit and look at the dealers. Let’s say the two players in our game are two dealers competing to sell the same car to one buyer. Each dealer has two strategies—offer a higher price for the vehicle or a lower price. The payoff that the dealer receives is either zero (when they do not sell a car) or it is the difference of the price paid by the buyer and the price the dealer paid for the car. The dealers’ prices are such that Dealer A’s low price is lower than Dealer B’s, but Dealer B’s high price is lower than Dealer A’s. Also, we will assume that the price the dealer pays for a car is strictly less than any price that dealer will offer and the buyer will always choose the lowest price.
In this situation, Dealer A’s dominant strategy when competing with Dealer B is to offer their lower price. On the other hand, Dealer B hopes that Dealer A might offer their high price, in which case Dealer B can can compete and even make a decent commission if they offer their high price.
Looking at this scenario, one might wonder why the dealer offering the lowest price for a car doesn’t wipe out the competition or why there isn’t an agreement between dealers to only offer their high prices and then split the higher profit. Considering the latter is illegal, let’s consider the first scenario. The reality of car-buying is that there are a many more factors involved than in our simple game. One explanation for the continued competition among dealers that offer unequal prices is that not all buyers are savvy enough to pit dealers against each other. With this application of Game Theory, it’s easy to see that getting just two dealers to compete can lower the price for the buyer. In conclusion, there are a lot of contributing factors involved in buying a car, but Game Theory demonstrates that getting multiple dealers involved is one of the most important strategies for a car buyer.
Source: http://www.moneycrashers.com/how-to-buy-car-tips/