Microeconomics

What economic factors affect the demand for new cars?

The motor industry is one of the sectors whose fortunes seems to permeate nearly every part of the economy. Most of us know someone who works in the motor trade, and changes in demand and production have sizeable effects not just on the industry itself but on many supply-chain businesses and economic activity in areas where car production is concentrated.

In 2010 just over two million new cars were registered in the UK - a rise of 1.8% on the 2009 figure. The biggest single course of rising demand came from the fleet market which rose by over 10% in 2010, but demand for and spending on privately bought cars slipped following the end of the Car Scrappage Incentive Scheme. Crucially for the year ahead, the new car market is forecast to decline by 5% in 2011 to 1.93 million units - according to the Society of Motor Manufacturers and Traders “difficult market conditions continue.”

So what are the main factors that affect the market demand for new cars?

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1/ Strength of business demand for new vehicles.

These are cars bought as fleet vehicles for example by taxi firms, fleet cars required by car hire businesses and new vehicles used by utility companies and the police force. Demand for fleet cars picked up in the second half of 2010 but 2011 may see a decline in demand in part because of public sector spending cuts.

2/ Real incomes of car buyers relative to car prices

New cars are normal goods with a high income elasticity of demand. When real incomes are rising (i.e. pay is increasing faster than inflation) we expect to see an expansion of demand for new vehicles as they become more affordable. In 2011 this factor is likely to cause a fall in demand because millions of people have experienced either a pay freeze or a pay cut and this, together with higher taxes including VAT is causing real disposable income to fall.

3/ The cost and availability of motor finance (credit)

Some new car buyers pay in cash...