Price equilibrium for automobiles using demand and supply

Bizning Vakil By Bizning Vakil, 28th Jun 2012 | Follow this author | RSS Feed | Short URL http://nut.bz/435p70m_/
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In this essay, I will look at the factors that affect the general price of automobiles. Of course, these factors are non-price determinants of demand and non-price determinants of supply. I will also discuss the price elasticities for the market of automobiles.

Introduction

The market for automobiles has always been a large part of the countries GDP. Not only that, it also has been a big part of the International Trade through imports and exports. Even though it is a huge firm, there are many automobile companies and each company has its own contribution to the automobile market. This has created competition in the market. That’s why, the general price of automobiles move together up or down. In this essay, I will look at the factors that affect the general price of automobiles. Of course, these factors are non-price determinants of demand and non-price determinants of supply. I will also discuss the price elasticities for the market of automobiles.

Factors affecting demand and supply

Automobiles are considered luxury goods with many years for duration to last. Therefore, the demand for automobiles is positively related with the economic growth of the countries. Whenever there is extra income, people spend it on luxury goods including cars. And to provide these people with automobiles, firms produce cars. Of course, there are important factors affecting the demand and supply. These factors are the non-price determinants of demand and supply. They are given in the table 1.

Demand

First of all, the tastes of people should be explained. With so many options available in the car market, consumers began demanding cars with more features two decades ago. For example, from 1990 to 2007, the demand for air conditioning in automobiles increased rapidly . This caused demand for automobiles without air-conditioning to decline whereas for automobiles with air-conditioning to increase. As of late, however, people are becoming more aware of global warming and that the automobiles is one of the causes. Although their number is not great, still there are consumers using canceling their purchase in order to contribute to solve global warming. All these changes in the consumer tastes affect the demand for automobiles. And when the demand is law, the price of cars falls down until the supply restores new equilibrium price.

Secondly, the price of substitutes must be explained. The number one substitute for automobiles, or rather the usage of automobiles, is the public transportations. If the ticket price is noticeably low, many people may choose to use public transportations. This is especially true for crowded cities and for millions of students around the world. Consequently, this will affect the demand for automobiles negatively. As followed, a fall in demand will cause a fall in price. It is important to note here that because of the global warming, governments are taking necessary steps to encourage people to use public transportations rather than their individual vehicles. Thus, it is more probable that the effect by the price of substitutes will be high.

Next, the complementary goods to automobiles must be discussed. The gasoline is the famous complementary good to automobiles. If the price of gasoline rises, as it was in 2003, the demand for cars will fall noticeably. Reversely, if the price of gasoline falls, as it used to be many years ago, the demand for automobiles rises. But according to the US Department of Energy, the price of oil (which is used to make gasoline) has been always rising (with very small exceptions). It means that the effect by the complementary goods will be negative on the demand for automobiles in the future, add to that the movement by the ‘global-warming-preventers’.
Then income distribution must be explained. Income distribution is commonly from the rich to the poor. With the increased income level, the poor may be able to purchase an automobile, provided other factors don’t influence him against his decision. Therefore, the demand may in fact rise the rich still buys and the poor now can buy. (From this perspective, demand for hatches or luxury houses may decline because these are the luxury goods for the rich!)

Finally, future expectations must be explained. The future expectations range from common belief to individual belief that the price will rise or the supply will decrease. In either case, people purchase more or less automobiles. For example, currently, people think that the low demand for cars due to the slowdown in the world economy will bring the prices down. Therefore, they may have been postponing their purchases. However, determinants of the demand are not the only factors affecting the prices. To any change in demand, supply responds, too. Therefore, people postponing their purchases may not win as much as they expect.

Supply

The supply of automobiles is an enormous process. Currently, there are more than 176 car manufacturers in the world, including GM Uzbekistan in Asaka, Uzbekistan. These companies are always on the lookout for bigger market share or new markets. They watch the demand for the products and try to respond to any change in it as soon as possible by either increasing or decreasing the supply. However, changes in supply are not only to respond to the changes in demand. There are factors, which affect the supply that are independent of the changes in demand. These factors, known as ‘non-price determinants of supply’, are mentioned in subsection ‘factors affecting demand and supply’. So, let us look at each one of them.

First of all, the production costs must be discussed. Speaking from the economics terms perspective, the costs of production are given in the table2.

For example, if the workers’ union demands higher wages, or government imposes a new regulation protecting the environment or raising the interest rates, the automobile supplying companies incur higher cost of production. Because demand is constant (temporarily, at least), companies make changes in the supply, which directly affects the price level.

The profitability of alternatives is another important determinant and must be explained. However, it must be understood that the process of manufacturing automobiles is extremely complex and requires huge and expensive equipments. So, the usual explanation in the economics ‘can switch to the alternatives’ does not work here. However, usually the companies produce different automobiles, in other words, they have diversified their product line. For example, they produce light vehicles and trucks, or large automobiles and small ones. So if the price of one type of automobile changes, it affects the supply of other types of automobiles; the companies use up all their resources to supply more of the car whose demand is higher and less of the car whose demand is low (or unchanged).

Next, the aims of the producers should be discussed. Traditionally, it had been assumed that the only aim of the companies is to make profit. However, it has been studied later that the producers sometimes may have other aims than profit. Sometimes, the other aims can affect the supply level and this, in turn, affects the price of the product. For example, if we assume that the automobile companies are at dog-eat-dog competition and want to destroy each other, they may aggressively increase the supply level in hopes that the lowered price of automobiles forces the weaker companies out of business (because the increased supply would have caused the price to drop down noticeably.)

The future expectations must be explained, too, as it affects producers in the same way as consumers. For example, if the automobile companies believe that the price of gasoline is going to be cheap, (gasoline and automobiles are complementary goods!), they will store their products for the future. This action causes the supply to be low and, consequently, the price level to be high. Or for example, if American automobile manufacturers believe that Japan intends to export a huge number of cars to the North America, American companies increase their supply, which drives the market price lower. (This is also an example for ‘the aids of the producers’ because here the aim of the producers plays some role in affecting the automobile price.)

Finally, the unpredictable events or nature acts play another role. They are flood, earthquake, terrorist attacks, etc. Naturally, the unpredictable events can affect all the non-price determinants of both demand and supply and, through them, affect the price. If anything happens within the company, i.e. earthquake or fire destroying the equipment, the company must replace the damaged parts – a big change in the cost of production. Or if anything happens in oil producing countries such as Iraq-Kuwait war in 1990, Iraq war in 2003, this has some indirect effect on the price of automobiles, because, as mentioned, gasoline and cars are complementary goods.

Price elasticity of demand

Price elasticity of demand is the responsiveness of the quantity demanded to a change in the price. It is calculated using this formula: Pe.d=∆(%)Qd/∆(%)P. And, according to the elasticity rule, there are three cases:

Elastic demand = E>1
Inelastic demand = E<1
Unit elastic demand = E=1

According to S. Mongrain , the price elasticity of demand for automobiles is 1.8. It is inelastic demand: a small percentage change in the price leads to a big percentage change in the quantity demanded. Therefore, demand for automobiles in the graph on the right is flatter.

Price elasticity of supply

The price elasticity formula is similar to that of demand. Instead of percentage change in quantity demanded, we use percentage change in quantity supplied: Pe.s=∆(%)Qs/∆(%)P

Obviously there are many factors that determine the price elasticity of supply of automobiles. First of all, changing the level of supply is not an easy process. So the response of supply to a change in price is slow.

Conclusion

Having analyzed the factors of both demand for and supply of automobiles, we can say that there are many factors that can cause the changes in the price of automobiles. The non-price determinants of demand such as people’s tastes and expectations, price of substitutes and complementary goods have all played role in affecting the price of automobiles. Similarly, the non-price determinants of supply such as the costs of production, profitability of alternatives, producers’ expectation and aims have played role, too. Since the price elasticity is more than 1, we can conclude that it is elastic.

Reference

Andrea Wielgat (March, 2002), Air conditioning Demand to Continue, available at: <http://findarticles.com/p/articles/mi_m3012>
US Department of Energy, Energy Information Administration, available at: <http://www.eia.doe.gov/emeu/mer/petro.html>
http://en.wikipedia.org/wiki/car_manufacturers
Elasticity PowerPoint presentation, by Steeve Mongrain, 2005, Worth Publishers

reference for photo: http://topnews.com.sg/images/China-Auto-Market.jpg

Tags

Automobiles, Cars, Demand, Demand And Supply, Economics, Foundation Of Economics, Price, Price Equilibrium, Supply

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author avatar Bizning Vakil
An economist by definition, a teacher by practice, a journalist by nature, I find it hard to find any one permanent place to settle down...

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author avatar MyShoh
14th Jul 2012 (#)

economics, foundation level, i guess

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