Principles of Micro Economics - Assignment Example

1. United States (US) has millions of vehicles in the country which are registered. The competition in this sector is very tough. It has nearly all the major vehicles producer in the country. This has given rise to price war and customers are getting lots of option. Some of the producers which are there are Ford Motors, General Motors, Chrysler, BMW, Honda and Hyundai. This puts a lot of pressure of different companies. This takes the US market towards perfect competition. It also satisfies the assumption of perfect competition as companies here earn only nominal profits. There are many producers of cars like Ford Motors, General Motors, Chrysler, BMW, Honda, Hyundai and many others. This leaves the company with very little to alter the price. Thus the prices are very similar and there is not much difference. This makes them more of a “price taker”. (Miller, 2008 pg 27) “The products produced are more or less similar” (Miller, 2008, pg 32). Every manufacturer has cars in all segments. Like in the luxury class, economy class and so on. Their cars are also very similar with very little difference to choose from. Thus, customers have a choice to make. The information with the customer regarding the prices of car is there. In case there is difference then the customer has a choice to pick other. As there is complete information it creates healthy feeling among the consumers. There is also complete information regarding the way the cars are manufactured and the technology used. When a company supposes Ford comes with a new technology others follow suit. Thus information and technology is free to pass. There is freedom of companies to enter and exit the market. There are certain norms of the United States (US) government which the company has to adhere to and it is similar as every country has so but there is no legal barrier. This helps the company to decide its future course as there is freedom for both. Here also car manufactures try selling their car which will fetch them maximum profits. “This is when the marginal revenue = marginal cost” (Miller, 2008, pg 37). Since, there is so much competition this situation is also there. This is also seen in the diagram below. It can be seen that price is determined where supply matches demand for the market. Figure 1: Optimization of profit $ MC $ S ATC P AVC D Thus the US car market has lots of companies moving the market towards perfect competition 2. The demand for US cars has slowed down due to decrease in demand. This has been due to the fact that consumers are saving more fearing the recession. This is also caused due to “more players in the market as customers have more choices and this has affected the sale of each company” (Miller, 2008, pg 32). “The market size has not grown” (Miller, 2008, pg 43) as the increase in the number of players thus affecting the demand. This can also be understood better when we look at the following graph Figure 2: Demand and Supply of cars in US market Price S D Quantity This is what the normal demand and supply should look like. This is when all the conditions are favourable. When there is “a change in demand due to decrease in demand the curve shifts downwards” (Miller, 2008, pg 44) and we get a new price at the same supply condition. Figure 3 Demand and supply Here it can be seen that the decrease in demand from D1 to D2 causes a decrease in sale of car and also the price falls from P1 to P2. This will make the suppliers also change the supply of cars so a new equilibrium will be formed which is shown below where due to decrease in supply the price and the quantity of car changes and an equilibrium is achieved somewhere in between Price P1 and P2 at P3. Similarly for the quantity supplied of car. This is shown below. Figure 4 Demand and supply This also puts pressure on the profits as due to decrease in production the cost of producing one car is rising. This is because it is not possible to “reduce the fixed cost” (Meghan, 2009, pg 6). As a result the average cost is increasing. For example General Motors produced 1000 cars at a fixed price of $810 per car and variable cost of $25000. Now due to competition the demand is less and General Motors produces only 900 cars. This raises the fixed cost as it cannot be reduced. Fixed cost now is 1000 X 810/ 900 = 900. Thus there is an increase of $90 per car. Further there has been a decrease in selling price due to which it is exerting extra pressure on the profits and affecting the company. 3. It is not possible for Ford Motors to reduce the fixed cost in the short run. “It is not possible for the company to alter the factors of production in the short run. Fixed cost is the amount that has already been invested” (Miller, 2008, pg 47). Ford Motors has also done so. So, if they do not use those fixed expenses then it will be sunk cost for Ford Motors. Firms continue their production till they are able to recover the variable expenses. This is so because that expenditure has already been done so if the company is able to get that back the variable expense it will continue. There is a relation between fixed cost, variable cost and total cost. This is shown in the graph below Figure 5 Cost graph Here, it is seen that “fixed cost is the expenditure which is same for a long period of time” (Miller, 2008, pg 47). “Variable cost is the cost which is done to produce one car and varies with the number of cars produced” (Miller, 2008, pg 48). So, the total cost is the sum total of both. Here the fixed cost remains the same irrespective of the number of cars that is manufactured. So Total cost = fixed Cost per unit + (Variable cost * Quantity) Where fixed cost per unit = Total fixed cost / Total quantity A thing to look out here is that the “total cost starts above zero” (Miller, 2008, pg 47). This is because even if Ford does not produce anything it will have to incur the fixed cost associated with it. “The variable cost starts from zero because if the company doesn’t produce then the cost is zero. The difference between the variable cost line and total cost line is the fixed cost which is the same throughout because it is calculated after considering the number of products produced”(Miller, 2008, pg 48). When the number of quantity produced increases the average total cost falls. This is also shown in the graph below. The increase in the number of car produced causes the denominator to rise where as the numerator remains the same so the cost curve bends as shown by the Average Fixed Cost (AFC) curve. Figure 6 Average cost graph Thus Average Fixed Cost (AFC) is affected by the quantity of cars that is produced. 4. Ford Motors and General Motors have been take full advantage of the economies of scale. This is due to better production methods adopted by both this company. Ford Motors and General Motors have brought about “a change in the assembly line of producing parts used in cars due to which it was able to get the benefit” (Mitchell, 2006, pg 1). It developed its method and used interchangeable parts in the assembly line. This helped to assemble it faster. This reduced the cost and also the labour used. This increased efficiency. This helped the company to reduce cost and gain advantage. “Using different technology also played part. It used a chain driven network to transport the goods to the site” (Mitchell, 2006, pg 1). This helped in saving cost. Thus it helped the company to gain. This helped the company immensely. The unskilled workers were also able to use it. By doing the same thing again they became efficient and this helped the company to reduce cost as the efficiency multiplied. This is shown below Figure 7: Economies of scale Here it can be seen that due to increase in the efficiency the cost has reduced and this has led to increased production. This has been mainly due to improvement in the way the car is manufactured. This has helped Ford to improve its production capacity and gain advantage from it. 5. Ford Motors and General Motors are going through a transition phase. It is facing problems in sale. This has caused company to cut cost. These costs are those which cannot be directly attributed to the cost. This has also forced the company to come with different sales tactics. Ford Motors is working on the average vehicle incentive where they give customers a cash incentive. According to the information in case, they have increased it to $2,827 but still have not been able to generate an increase in sale. It has further reduced its sale by 5% . According to case, even General Motors who is working on the same line is giving an incentive of $2,915 but still their sale also fell by 5%. This is a cause of worry as the company is losing on cash. Both this company needs to work on some other strategy as it is not fetching them good return as sale is falling. They need to come with strategy like “better advertisement by coming up with new commercial by looking for faces who are prominent” (Thomas, 2009, pg 1). The other could be “increasing the warranty period” (Thomas, 2009, pg 2) as this will make the deal more lucrative as product in the market are similar. The other could be “better complaint handling by having more calls centres” (Kotler & Keller, 2009, pg 134). The company can also come with “loyalty programmes and special programmes for their customers which attract them” (Meghan, 2009, pg 12). This will help both the companies to gain some lost ground. It needs to be continuous and in the long run it will help. They should also look to eliminate the unnecessary cost. 6. The car industry in US is under distress. There are various reasons which support whether the government should bailout or not. Bailing out Ford and General Motors is important because “it will help to save millions of people losing jobs” (Krugman, 2008, pg 1) At this time of recession it is important to do so though filing for bankruptcy under Chapter 11 would help but it would create negative impression and would further lead into recession. Having bailing out this company “would be beneficial in the long run as several small ancillary industries work for it and this sector contributes heavily to the growth of the economy” (Wagoner, 2008, pg 6). Not bailing out would also “put pressure on pension liabilities as the benefit has to be transferred” (Abraham, 2008, pg 1) put more pressure on the exchequer. This will also lead to creating a negative image. It would also pass on the effect to the “other sector as steel, aluminium, iron, copper and other metals are also consumed in huge quantity” (Granholm, 2008, pg 1). This will affect the entire world. Thus, it can be seen that bailing out both the major will be good. Of course it will make other feel that they will be bailed out any time but seeing the situation of the economy is currently facing bailing out will be beneficial. Reference Abraham S, 2008, “Should chapter 11 be the final chapter”, New York Times, United States Krugman P, 2008, “Should the three big car manufacturer be bailed out by US government”, Professor of Princeton University, http://bigthreeauto.procon.org/viewresource.asp?resourceID=2026 Kotler P & Keller L, 2009, “Marketing Management”, 13th edition, Prentice Hall of India, New Delhi Granholm M, 2008, “Save automakers to save economy and security”, CNN, United States, http://www.cnn.com/2008/POLITICS/11/13/granholm.energy/index.html Meghan G, 2009, “Ford Motor Company case”, Volume 12, Issue 3, Pg 4-17, United Kingdom, (Market Wire) Miller J, 2008, “Principles of micro economics”, Tata McGraw Hill, India Mitchell R, 2006, Advertisement 2006“GM drives economies of scale”, Computerworld Daily Newspaper, Detroit, viewed on 2009 http://www.computerworld.com/s/article/267929/Driving_Economies_of_Scale_in_IT Thomas G, 2009, “The motor industry code of practice”, Strategies, United Kingdom Wagoner R, 2008, “Why GM deserves support”, Wall Street Journal, Volume 15, Issue 3, Pg 3-12, (Wall Street Journal) Read More