Impact of un-utilized assets : A Mathematical Model

A few weeks back I was wondering what happens when we buy a car but don’t drive it. While the automobile industry witnesses a growth but is it something that increases the drag on the economy.

I spent a few hours to work on a very simple model to find what happens in various consumption scenarios.

Approach:

I had to create a simple-one -product economy. Hence  I assumed that

  • Our economy produces cars each worth Rs 12 lakhs.
  • Average utility lifetime of the car as 1lakh miles
  • Additional spends required based on consumption as 5 Rs per mile

I also simulated 6 different scenarios from a household’s perspective. namely:

  • Scenario 1: Normal usage. Uses for full life of the product
  • Scenario 2: Stops using after a time. Does not sell it or buy another
  • Scenario 3: Stops using and sells it off but doesn’t buy another
  • Scenario 4: Stops using, doesn’t sell and buys another which is used
  • Scenario 5: Sells this and buys another which is used
  • Scenario 6: Doesn’t sell, buys another, stops using that also and buys a 3rd

Once these assumptions were plugged in, I calculated a few ratios and interesting things emerged.

 Unutilized Assets

  1. The value derived from each product drastically changes between two similar scenarios where the old stuff is traded vs where it is not sold. Does this mean that in a resource constrained economy, a market place optimizes the return of invested resources through higher utilization?
  2. In the scenario 6, income generation is highest for every 1 Re spent by the households. So maybe hoarding is a good strategy when domestic income generation is important. On the contrary imagine if we do this in categories where we import the products – we might be supporting Chinese economy more than we ever wanted to.

Not knowing fully well what these ratios meant, I spoke to my Professor friend Dr Dash who gave some very interesting path of analysis. Essentially what he mentioned was that I should look at this top down rather than at a micro level. He also mentioned about ICOR – Incremental Capital Output Ratio – how much additional capital do we require for each unit of GDP increase. E.g. an ICOR of 3 means we need 3 Rs for every 1 Re contribution in GDP.

  • Assume a market size of 75 Bn USD and lets say one third of this is from private cars. Hence a market of 25 Bn USD
  • Now assume that 5% of all cars produced in a year lie idle, which means about 1.25 Bn USD worth of cars remain idle. (and this is incremental value of locked capital every year)
  • So with an ICOR of 5 , these un-utilized cars translate into 6.25 Bn USD worth of capital that is “wasted” every year.
  • But where it became tricky for me was that whether the asset is utilized or not, the GDP is impacted depending on ICOR. So is this a case of smarter capital allocation? Would this “wasted capital” helped us in producing some other more needed product or service?
  • A very interesting and probably extreme case of this top-down analysis would be the scenario where the asset is imported. In such a case, a reduction in “wasted capital” would result in better trade-balance
  • With a marketplace, if 40% of these cars are sold in the second-hand market, then we free up that much capital.
  • Moreover with cars available at a lower price, many category shifts might happen. E.g. say a Maruti Alto being sold in the second hand market might attract a person who was in the market for a 2 wheeler earlier.

The car you bought but don’t drive, hurts the economy

While on my evening walk I recently noticed an old Mercedes gathering dust in the neighborhood – the car hasn’t moved in the last 10 years. Or maybe more.

While this rude treatment meted out to the Merc pained me,  I noticed that there were many other cars which had rusted completely just being parked out in the open.

So I asked my economist wife – what is the impact of such reduced life cycle of an asset on the overall economy.

Unused Cars

What I was thinking was this:

  • At an individual household level, this was clearly capital being blocked or even wasted. As the same could have been re-utilized in buying another asset or investing elsewhere.
  • At a more macro level, the automobile industry was not really a loser. They might end up selling more cars if many individual households just buy cars and don’t use them. So where in our country’s GDP calculations would this waste be accounted for.
  • A car that is used regularly results in more spends – on fuel, maintenance, tires etc. All of which stimulates the down-stream industries and hence positively impacts the economy.  Discounting the fuel-price etc. So does it mean that if a society in general fails to extract the true value from its assets,it fails to stimulate the ancillary industries sufficiently? If so, would this apply to apparels and other items we usually stock?
  • The fact that the car was not sold-off meant that the supply was reduced in the 2nd hand car sales market. Does such a trend result in higher prices in the used-cars market? Would selling off an un-used asset lead to higher supply and hence a more vibrant used-assets market? if yes, then maybe a Quickr or OLX should pitch to the finance ministry and get some more funding.

Too many questions and the wifey says that its way too complicated for me to comprehend. So while I work on a mathematical-excel model to quantify this, do share your point of view.

Would our economy have a positive impact if we would learn to extract more value from each of our purchases.