Wednesday, December 14, 2011

Unit 3: January 2010 Question 12 - US Motor Vehicle Market



a)    Market Share is the percentage of total sales in the market that a company has. The market share of Japanese car manufacturers is set to increase in the long run because “the ten most popular fuel-efficient vehicles sold in the US are all made by Japanese and German car manufacturers”. Because of “rising petrol prices”, consumers of cars want to purchase cars that are more efficient and do not require as much petrol demand as the “petrol guzzlers” such as GM’s Hummer. Therefore, consumers will demand more efficient Japanese cars and because of increasing demand the market share of Japanese car manufacturers will increase.

b)    REFER TO DIAGRAM:

Variable costs are costs which change when output changes. Petrol prices are increasing so it costs more to produce car parts such as tires. Costs are also increasing as “employee costs have increased at a faster rate than inflation”. Falling demand is caused due to the fact that there are new entrants into the market such as Japanese and Chinese manufacturers. Consumers are demanding more Japanese cars as they are becoming increasingly fuel efficient and so demand for US motor vehicles is decreasing. The diagram below illustrates how the AC cure and MC curves have shifted upwards as variable costs are increasing. The diagram also shows how AR and MR have decreased and shifted left due to the decrease in demand for US motor vehicles such as Ford. Therefore because the AC curve is higher than the AR curve a loss is made and is shaded in the diagram – this leads to a decrease in Quantity from Q to Q1.

c)    Dynamic efficiency – is the difference between actual efficiency and potential efficiency. The fact that US car manufacturers are supplying cars at a loss illustrates how the US car manufacturers will indefinitely suffer from dynamic inefficiency. The firm will not be able to reinvest because they are not making a profit and so therefore will not be able to increase research and development into features such as a more fuel efficient engine or new features in the car such as a TV screen. Demand for cars is elastic because there are many choices from many international car manufacturers so as reinvestment is limited the car will not have a quality as high as the quality of other cars such as the fuel efficient Japanese cars. Hence, demand will fall even more and because of the loss, dynamic inefficiency will be present in the US car manufacturer.
Eval. The government could subsidize any of the big firms as they want to keep their local cars competitive against the foreign cars. If the government does give subsidies to the firms then the cars manufacturers will be able to reinvest the money and increase the efficiency of car production such as building a factory in every single state to reduce transport costs. However in this current climate this is unlikely as governments have limited capital and will use it to reinvest in major industries such as improving education.

d)    A Loss is where revenue is lower than costs. Therefore in order for a US car manufacturer such as GM to reduce it’s loss it has to either increase it’s revenue or decrease it’s costs.

To increase revenue, I believe GM needs to diversify and produce cars to incorporate the different market segments which demand cars. For example, they should continue producing “petrol guzzling” Hummers but try to accommodate a car for a market such as a small car for couples or single people, or an SUV for families. Diversifying products means that they can expand into different markets and so have a higher chance to gain more revenue.

Another way revenue can increase is if the “‘big three’ car manufacturers” collude together. Collusion is when firms work together to reduce competition and gain benefits such as higher profits. Collusion can occur in this industry because there are a few large firms so trust can occur between them. Also, there is brand loyalty in the car market so this means there are high barriers to entry because it will be hard for new entrants to enter the market and steal market share from the big firms. Finally the US car manufacturers seem to produce quite similar cars meaning that collusion and working together can occur.

Eval. Cross subsidizing can only occur when one product is making a profit because then this profit can be used in research and development to produce and innovate new cars such as an SUV to accommodate the family yet it has the engine of a race car. Just being able to develop new cars for different markets will also take a large amount of investment into advertising the cars in motor vehicle magazines and TV. All of the 3 major firms are making losses and therefore I believe none of them will want to spend any money into developing a car because if the product fails and doesn’t sell as much as predicted then even more money is wasted in the research and development of this failed product.

Eval. Collusion is illegal – The competition commission has the right to fine firms up to 10 % of their revenue if they are found to be taking part in collusive practices. In this current climate and due to the fact that all of them are making massive losses, I believe that the major US car manufacturers do not want to risk getting fined, losing even more revenue and ending up with an even bigger loss. Also, I believe that there is still the possibility for new entrants into the car market. Because of increasing petrol prices there is an incentive for car manufacturers to produce sustainable and ‘green’ cars which will be ideal in the future. Therefore, if a manufacturer produces a car which is powered by the light and is extremely convenient then there is a possibility that they can grab a percentage of the market share and thus reduce the power of the major firms in the collusive agreement.

e)    Chinese firms may find it difficult to sell their cars in the US vehicle market for many reasons.

Firstly, the US government may subsidize US car manufacturers and help them get rid of their excessive losses. This assistance may occur because cars are considered important goods for the economy as transportation is vital to the running of many industries such as Post mail. The subsidization of the US car manufacturers means that they can reduce their costs of production (and supply the cars at a lower price) or even reinvest and improve their current car range e.g. reinvest into developing a GPS system for all the cars. This means that Chinese firms may face barriers because their costs of production may be higher than the US firms so they must supply cars at a higher price to cover costs. This will lead to less demand for their cars because the American consumers can just buy the cheaper option – the US cars.

Also, I believe there is brand loyalty towards the automobile industry. Consumers tend to buy the same car from the same manufacturer if they are happy with the car and its efficiency. Therefore it may be difficult for Chinese firms to enter the market and persuade consumers to switch – there is a slight level of inertia because usually when people feel comfortable with their car model they tend to stay with that same car and just buy the newer version of the same car type every few years instead of switching. This is illustrated as GM has 27.2% of the market which legally makes it a monopoly (as it has greater than 25% market share), this is shown in Figure 1.  Hence, Chinese firms need to have a unique selling point or something innovative and new to encourage consumers to try out the Chinese cars. For example, a car that can last 20 days without needing to be refueled with gas is one unique selling point which no other firms have. This is a difficulty and a barrier to Chinese firms because they need to spend large amounts of capital to research, develop and promote these new innovative cars. These high sunk costs (costs which can’t be retrieved when leaving the market) will discourage Chinese firms from selling cars in the US vehicles industry and act as a barrier to entry.

Tariffs are also another reason why Chinese firms would find it hard to sell their cars in the US industry. Tariffs are taxes placed on the importing of products into the US. Importing cars into the US will lead to heavy taxation and therefore the Chinese cars will be sold at a higher price compared to the US cars. A higher price could lead to a fall in demand for Chinese cars and so act as a barrier to entry because Chinese firms will find it hard to compete against cars which are selling for a lower price. This is because cars are elastic as there are many firms supplying cars and so a high price for Chinese cars means that demand and revenue will fall so Americans will opt for their American cars which are sold for a cheaper price as they are not taxed.

Eval. Subsidizing is unlikely in this current economic climate as the government is in massive debt. The government is highly unlikely to grant money to the struggling US car manufacturers and will instead use any money available on infrastructure and paying off its debt. Also if subsidizing does actually occur, the significance of it depends on how much the government actually grants the US firms because the firms are making losses of around 1 Billion Dollars! So the grants given to them may not be significant enough to affect their business model or production methods.

Eval. A higher price on Chinese vehicles does not necessarily mean that it is a disadvantage. A higher price on elastic goods is a sign of high quality and so this may act in the advantage of Chinese firms because consumers who want to buy a luxury vehicle will choose an expensive car as they believe it will have the high quality they demand.

Eval. The tariffs may not be significant because the tax could be a very small portion of the price of the car and may not increase its price to an extent which is significant to the Chinese firms. Also, tariffs may not even be put in place by the US government because it can lead to two main problems. Firstly, the American consumers will have less choice when it comes to purchasing cars and secondly, it may lead to political retaliation from the Chinese government i.e. they may stop US firms from selling their cars in China. So basically, if tariffs do actually occur they many not even be very significant and also they may not be put up in the first place as it may lead to disadvantages to the consumer as well as the government.