Microeconomics Relating to Car Industry

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Table of Contents

Introduction
Market structure of the industry
Production
Labor
Consumer market
Conclusion
References

Introduction

Microeconomics is a subset of economics dealing with the individual elements in the economy and how they interact to achieve their own economic goals. There are various individual units in the economy that are examined. The main two are the household and the business units. We can also examine the government, though this would normally border on the macroeconomics side (Campbell, 2004). In examining the car industry, we should examine how the car industry affects the individual units: namely the firm and the household, and put into consideration recent events and phenomena noted within the international car industry that are applicable

Market structure of the industry

The car industry takes has been under debate as to the market structure type it adopts. This is because it resembles two market structures: oligopoly and monopolistic competition. Oligopoly has a few sellers competing with each other with similar goods and services. The monopolistic competition also has a few sellers selling similar goods and services. Their products are highly differentiated so as to attract customers. While one might argue that the car industry is a monopolistic competition due to the differentiation experienced, others think otherwise. As pointed out in The Shortrun (n.d.), the industry is an oligopoly due to the influence these firms exert over the market. They can, for example, withhold supply, a trend within the luxury goods market. Oligopolies also experience barriers to entry. These barriers as noted by Campbell include price barriers due to the capital-intensive nature of the business (Campbell, 217-234, 2004).

The characteristics of the oligopoly market are seen extensively in the arrangement and format of the car industry. For example, there is mutual interdependence on the level of pricing. Therefore the pricing of one firm determines the pricing strategy of its rivals. If one firm decreases the price, the other firms will rush to decrease their prices in response. If the firm increases its price, there will be no increase in the prices of other competitors (the short run). This has been seen in the price wars that have characterized the car industry. Loveday notes, in the recently created car segment, hybrid cars, Toyota has led the charge to slash their prices. Toyota has continuously lowered the prices of its hybrid model, the Toyota Prius, in a bid to take out the Honda version, the Honda Insight. The decrease in price by one car maker led to the subsequent reduction in price by the rival (Loveday, 2009).

Another characteristic of oligopoly is the collusion of two sellers in a bid to use their new strength against one seller. The new synergy created in terms of capital, market connections, and technology puts them at a better level against the rival (the Shortrun). The main victim of such gang-ups has been Toyota. The recent mergers of Daimler-Benz taking over Chrysler is an example of how firms merge to survive. The superior network and synergy created was an advantage that allowed the firm to survive (Economics help, 008).

In the shortrun, it is cited that oligopoly, though, economic efficiency is not reached. This is because of allocation and production inefficiencies. Since there is a tendency to operate below full production capacity, allocation is not achieved. There are also the inefficiencies experienced due to the lack of perfect knowledge by the consumer (the Shortrun).

Production

The firm must be in a position to efficiently produce output in a manner that does not waste. Economic efficiency simply means using an output method that utilizes the most economic combination of input to produce a specific output level (Columbia, 2009). Operation within the Pareto levels means that the inputs are quantified in the right measurements in order to produce a level of output that is cost minimizing in production while profit-maximizing in the market. As seen, consideration in production takes on efficient allocation of input so as to produce the right quantity of output for the market (Columbia, 2009). However, as seen, in oligopoly markets this does not exactly happen due to inherent inefficiencies (short run).

One of the ways of increasing the efficiency of production is by cutting the cost of the inputs. The role of scientific research comes in here (Campbell, 260, 2004). The car industry relies on technology and research to both improve its products and seek more efficient production methods. The industry, being technology-intensive needs constant research, forcing it to be a fixed cost in order to be competitively relevant. In this respect, technology bears weight on the firm. However, when used properly, the resulting output and cost savings in this sector are worth it (Columbia, 2009). With respect to econometric computation, the cost of technology is not consistent in its output. One project may not produce the expected result but may cost a lot. Another project may cost significantly less but the resulting financial implications are huge (Columbia, 2009).

A practice used within the motor industry to cut costs is the use of common parts for various models. For example, Chester (2005) notes that Toyota has adopted this strategy and has used this technique of partial reduction to cut costs. Under a flamboyant venture, they engaged actively with their suppliers in the cutting of part varieties so as to reduce costs. For example, they consolidated the production of their air vent parts in order to achieve a cost reduction of 28%. The consolidation involved consolidating the parts from 28 to only 4 (Chester, 2005).

Within production, there has always existed a trade-off between capital and labor. The production possibility frontier takes into consideration how much labor and capital are used to produce to determine how much output is possible with the various combinations of the two. As seen in the model of the production possibility curve, the more of one factor increased, the more production output is possible. The production possibility curve, therefore, shows us how much the firm can produce given a certain amount of input (Campbell, 150, 2006). Within the car industry, as stated before, the role of technology is important. Within the context of output, technology helps the firm produce both greater and more quality output (Plunkett, 2008). With an improvement in technology comes an improvement in the quantity and quality of output. In the industry, this has meant that the production process has greatly speeded up and the companies are able to respond even faster to the needs within the market. This has been made possible due to the increase in technology (Plunkett, 2008).

Labor

The microeconomics of labor involves finding how much of the labor is needed to match the production level needed. In a basic overview, the basic level of labor necessary is attained where the value of the marginal product produced is greater than the value of the marginal cost of hiring the labor. This shows that the output of the laborer is greater than the cost of hiring the laborer. In the industry, there is also the issue of technology versus human labor (Campbell, 245, 2006)

In the car industry, wages are not simply set with only one factor in mind. One must consider the effects of the government and trade unions on the setting of the wage rate. Other benefits that accrue regardless of output are also a factor of concern to the producers. Factors such as terminal benefits are expenses that are incurred without an increase in production. They, therefore, become a fixed cost due to their mandatory nature while the output does not increase. An example of how it affects the car industry is the case of GM. GM has an overwhelming commitment in terms of retirement benefits that its labor union, UAW, forced it to incur.

Not only does it have huge retirement benefits, but it also has huge working benefits that put the wage rate for an average employee at 70 dollars an hour in late 2008. The figures for 2006 show that only 54% of their pay came in the form of cash (Sherk, 2008). Because of this and other inefficient competition factors, GM has dropped from doing well to getting government bail-outs. Removing these benefits in light of their financial position is not as easy since this now involves legal and social repercussions (Sherk, 2008). There are also theories that the more the wage the less amount of work that is done. This is however not true for workers within the car industry as shown by their working hour’s statistics. The statistics show that they take extra hours aggressively due to increased pay during these hours. The average number of working hours per employee in 2006 came to 315 (Sherk, 2008).

With this large number of working hours, the producer should be satisfied that his input is bearing output. This is not the case. The phenomenon known as shirking comes into play (Campbell, 293, 2006). The employer really has no knowledge about what the employee is doing, and whether they are working as much as they should. With no means of knowledge, the employer sets the wage rate at the average output. This would typically discourage the exceptional worker. This is solved through the use of output reward schemes that would encourage the workers to perform better. In higher management positions, the use of stock options has resulted in the abuse of these provisions. Indeed these were the questions raised during the move to give stock options to the executive of the carmaker giant Toyota in 1998 (Shibata, 1998)

Consumer market

Microeconomics of marketing

Within the marketing domain, there is a traditional inefficiency brought about by welfare loss. The loss is brought about by the oligopoly inefficiency of lack of perfect knowledge. Because of this, Sperling (2001) notes that the consumer is unable to make a knowledgeable choice and is forced to rely on the knowledge of the producer. The goods are either good or inferior. The good goods are of higher quality and resultantly more expensive. However, the inferior goods are of lower value but are sold at the same price due to the ignorance of the consumer. This leaves the consumer at the mercy of the salesman. If the salesperson feeds him or her with wrong information, the consumer goes at a loss by purchasing a cheap product at a higher price.

However, if the information is true and the consumer takes a good product, the consumer welfare is preserved. Sperling (2001) also notes that in order to ensure that the consumer is making a good choice; the producer will offer him a guarantee, called a warranty, which will ensure that the product is good. The only trick is to ensure that the value of the warranty is expensive enough to lock out the faulty producers while still allowing the producer who is valid to access the market. This is seen in the car industry, particularly in the second-hand sales segment. The salesperson will try and offer you a deal that will allow one to purchase the product with a specified time period in which if the product faults, it will be returned. Such warranties are supposed to convince you that the car is good enough and the salesperson is willing to place a financial guarantee on the purchase (Sperling, 2001)

Microeconomics of the market

Consumer choice and purchase are of paramount importance to the industry. In fact, the whole point of production is to ensure that the goods are sold. The car industry is not exempt from this basic principle. As a result, the firm in this industry needs to find the application of the utility theory in the consumer market. The firm needs to find out what influences the utility, find the purchasing power of their target market, and ensure that they respond appropriately. The market segment as stated earlier is an oligopoly and therefore the response of the market will be significant. A reduction in price by one firm will cause there to be a considerable shift in demand (the Shortrun). The Shortrun also states that this shift in demand is not permanent as other firms will soon shift, bringing the demand back down. However, this fact enables us to imply that the price elasticity of demand in this market is significantly high.

In the car industry, there are various trends that are seen in the market that influence the choice and preference of the consumer. Plunkett has noted one of these trends is influenced by the cost and type of fuel that the car consumes. Over the past few years, there has been a world shift toward smaller and more fuel-efficient cars (Plunkett 2008). This is due to the influence of world oil prices. The price of oil internationally has affected the individual consumer, fuel being a complementary good (Campbell, 135, 2006). The price of the complementary good, oil, in this case, influences how affordable the purchase is in terms of initial buying and continuous maintenance. Therefore, the car industry will feel their demand is affected by the price of the complementary good. This move to get smaller and fuel-efficient cars in a bid to cut down on the maintenance cost is all in a bid to get the cars that fit within the budget limit and still maximize utility with the amount of money spent.

The type of fuel also matters. With technology striving to gain an alternative to traditional fossil fuels, hybrid cars have developed as a result. These cars are touted to be the next big thing for the automobile industry. The world has become increasingly worried about climate change patterns. Plunkett also notes that the automobile technology world has tried to develop alternative energy user cars that will be eco-friendly. Not only will they be eco-friendly, but they will also be economical since they will use less oil fuel, a major comprehensive factor (Plunkett 2008). With this in mind, car producers have run to produce technology-compliant cars. This has resulted in the price wars being witnessed, such as the competition between Toyota and Honda, another characteristic of oligopoly (Loveday, 2009). The demand in this market being elastic makes the price of the product important for the consumer.

Another trend within the context of the environment is the issue of legally compliant cars. In America, several states have already issued strict regulations in regards to emissions (Plunkett 2008). A consumer will logically prefer to buy a compliant car that will not cause him or her to endure legal repercussions as a result. This is factored in while assessing the value of the car. If the car is not compliant, it would be considered inferior and therefore the demand would be less.

Perhaps the biggest question considered by the consumer is whether they can afford it. The issue of utility is subject to the budget limit that exists for the specific consumer. This consumer will look at the car and will only purchase if the car is within their price range. The assumption of rationality will apply here. They will seek to maximize their utility but important to notice is that they will maximize it within the range of their budget (Campbell, 128, 2004). Therefore, the affordability of the car is important for the seller. A producer must make sure the car is good but is also affordable.

The question of affordable cars is very serious in this industry. Cars are made targeting various segments of the consumers and offering them utility in light of their needs. The producer must be able to create a product that appeals to the needs of the consumer while still remaining affordable. Einstein (2009) notes that Toyota, in their competitive strategy has adopted many ways of ensuring that the consumer can afford their product. One of them is to avail credit to the consumer to purchase. This was effective, particularly before the financial crisis. This strategy would enable the producer to create a kind of “pay later” scheme that would appeal to the average consumer, particularly because the purchase of a car is a significant expense (Einstein, 2009).

However, the issue of affordability has come under serious scrutiny around. The massive car losses around the world are an indication of the inability of consumers to purchase. Buckley notes that in, Britain for example, car sales have taken a massive blow with sales for October 2008 falling by 25% from the previous month. The rest of Europe has also recorded similar staggering figures with Germany recording an 8% drop and Spain a whopping 40% decline in October 2008 (Buckley, 2008). This drop has been due to a number of factors.

Einstein (2009) also notes that the massive job loss has resulted in the loss of consumer purchasing power. Since the purchaser can no longer afford to buy, the sales go down. Also, there is another phenomenon of the financial crisis that is taking a psychological aspect (Einstein, 2009). The job loss is creating a sense of job insecurity. This job insecurity is eating into the demand since the household is not willing to spend more. The household is more interested in saving rather than consuming. They are not sure that they will not have a source of income later. They also lack the financial confidence to engage in loan taking, a common aspect of car purchase. Since the purchase of a car is a relatively big investment, they would probably take a credit facility so as to purchase. At this time, the confidence to do so is low and therefore demand will suffer (Einstein, 2009).

Conclusion

In summary, the car industry is coupled with a lot of competitive factors that cause the industry to experience a lot of competition. The market structure it adopts, oligopoly, allows it to engage in market information manipulation due to a lack of complete information. However, the consumer must still be able to afford the product at the end of the day. We have also established that technology is a key economic factor, influencing its production quality and quantity, and by extension also influencing consumer preference. The dynamism of the tastes of the consumers in this industry makes the role of technology in speeding up the production process important.

Turning to the consumer, we must also keep in mind that the consumer’s tastes are changing and that their preferences are also influenced by the cost of the complementary goods in the market. This has been a big force in the car industry.

References

Buckley, Christine More jobs are lost as British car sales head for sharpest decline in 17 years Times Online 2009. Web.

Campbell R, McConnell & Stanley L. Brue, Microeconomics: Principles, Problems, And Policies. 2004. McGraw-Hill Professional.

Columbia link Production Theory Basics2009, Web.

Dawson, Chester, A “China Price” for Toyota. Business Week, 2005. Web.

Economics help Advantages of mergers, 2008. Web.

Einstein, Paul Credit Problem Cost 800000 lost sales. The Detroit Bureau, 2009. Web.

Loveday, Eric Honda will not Lower price of Insight: Ends Price War with Toyota All cars electric, 009. Web.

Plunkett Research Plunkett automobile’s industry almanac. Plunkett Research Ltd., 2008. Web.

Seeking Alpha Toyota verses GM/Ford Seeking Alpha 2006. Web.

Sherk, James UAW workers actually cost the big three automakers $70 an hour. The heritage foundation, 2008, Web.

Sperling, Scott, Assymetric Information. 2001. Web.

The short run, Oligopoly. Web.

Yoko, Shibata Japan discovers stock options 1998. Web.

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