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# How innovative financing will increase demand for electric cars

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Jae C. Hong/AP/File

(Read caption) In this file photograph taken December 2009, the 2011 Chevrolet Volt debuts at the Los Angeles Auto Show. General Motors Co. said Tuesday its Chevrolet Volt electric car will cost \$41,000 when it goes on sale in November. Would innovative financing techniques for cars like the Volt increase demand?

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Starting with Hausman's 1979 paper , empirical economists have been interested in the fact that most consumers prefer to purchase durable products whose costs are "backloaded." In English, we tend to prefer the air conditioner whose upfront price is cheap but that uses a lot of electricity in each subsequent year while we run away from products that are expensive today but are very inexpensive to operate (because they require little electricity) on an annual basis.

Environmentalists shouldn't be happy about this fact but the good news is that capitalism may have figured out a way out of this financing jam (the lease).
To see this point, suppose that there are two air conditioners called "A" and "B". A costs \$75 to buy and uses 20 units of electricity to operate while B costs \$200 to buy today but uses only 1 unit of electricity to operate. To keep this simple, assume that "A" and "B" are equally good at providing cooling and that each lives for 4 years and then dies.
Define r = your personal discount factor --- so you are equally happy if I give you \$1 this year or \$1+r next year. Assume that the price of electricity per unit equals P and this never changes.
A person will buy "A" rather than "B", if the present discounted value (PDV) of the cost of buying and operating "A" is less than the PDV of the cost of buying and operating "B".
So , if you buy A: the following algebra must hold for you:
\$75 + 20*(P + P/(1+r) + (P/((1+r)*(1+r)) + P/((1+r)*(1+r)*(1+r)))
< 200 + 1*(P + P/(1+r) + (P/(1+r)*(1+r)) + P/((1+r)*(1+r)*(1+r)))
With a little bit of algebra, you should be able to convince yourself that "r" must be very high for this person --- she must be very impatient and not eager to give up \$200 today in order to have the energy efficient appliance. Now if P = 0, this logic would fall apart.
Why am I boring you about this? In 2010, car companies such as Nissan are rolling out their electric vehicles such as the Leaf and the Chevy Volt. The news is full of stories about them such as this one .
To an economist, here is the interesting part:
"The Chevrolet Volt, the first mass-market electric vehicle from General Motors Co., will have a sticker price starting at \$41,000 when it hits showrooms this year, but it was the attractive lease offer that the automaker announced Tuesday that grabbed the attention of industry analysts.
Chevrolet plans to offer a lease program on the Volt with a monthly payment as low as \$350 for 36 months plus \$2,500 due at lease signing, a deal that could speed up adoption of the new generation of automobiles by making them competitive with traditional gasoline-powered vehicles.
In December, the all-electric Nissan Leaf hatchback is slated to go on sale starting at \$32,780. But it too will have a lease deal: \$349 a month for three years with an initial \$1,999 customer payment."
Note that Nissan and Chevrolet have "solved" the Hausman problem; they have converted the large upfront payment into a series of "small" monthly rent of roughly \$350 a month. This financing scheme will attract new buyers to try out the vehicle.
Now, I'm not sure if the math actually works out here. \$350*36 = 12,600 + 2,500 = 15,100 which is < 41,000. So it can't be the case that a "leaser" owns the vehicle after 36 months. What surprises me here is if the leasee can return the vehicle to Chevy, what is the resale value of a 3 year old electric vehicle?
So, while these numbers look fishy to me --- the big point remains --- until now --- academic economists have worried that people are too impatient to be willing to pay the upfront costs to buy green products --- leasing arrangements solve this problem and should help to stimulate demand.