Subsidies and pricing strategies in a vehicle scrappage program with strategic consumers

We consider the problem of a government that wishes to promote replacing old cars with new ones via a vehicle scrappage program. Since these programs increase consumer's willingness to pay for a new car, manufacturers (or dealers) could respond strategically by raising their prices. In a two-period game between a government and a manufacturer, we find equilibrium prices and subsidy levels. Our results demonstrate that price levels are increasing over time and are higher than in the benchmark case where no subsidy is offered. Furthermore, if consumers act strategically, then the equilibrium price levels will be higher than in the scenario where they behave myopically.

Automated summary

We analyze the government's vehicle scrappage program and the strategic behavior of manufacturers in response to increased consumer willingness to pay. In a two-period game, we determine equilibrium prices and subsidy levels. Our findings show that prices increase over time and are higher with the subsidy compared to the benchmark case. Moreover, if consumers act strategically, equilibrium prices will be higher than if they behave myopically.