Failing Auto Industry In Detroit

This article is about the effect on the local Detroit auto suppliers when the October monthly demand for new vehicles from General Motors, Ford and Chrysler, dropped substantially compared with that of the same time last year. This article presents many interesting points about Economics, and the concept of demand1 and supply2, income elasticity of demand, can be applied to this situation.

The supply failure of auto parts is mainly because of the remarkable drop in demand of the new vehicles due to the recession. Income elasticity of demand (YED) is a measure of how much the demand for a product changes when there is a change in the consumer’s income. The income elasticity of demand for vehicles, which can be classified as a superior good, tends to be high. In this case, when the consumer’s annual income decreased due to the recession, they stopped purchasing vehicles, which are non-essential, and shifted the demand curve for new vehicles from D to D1. Furthermore, consumers now have very negative expectations for the economy because of the recession. In this case, change in one of the determinants of demand called expectation, as when car buyers would not make such a commitment to own a vehicle when they can’t even secure their jobs. The unwillingness to purchase new vehicles during the recession from any of the local Detroit automakers also shifted the demand curve from D to D1. As a result of these changes, the new market equilibrium3 has gone down from P1Q1 to P2Q2. (See Fig.1), meaning that the market will be cleared at a lower price and quantity.

Connections can be made between Fig.1 and Fig.2 because when the quantity demanded for new vehicles in the Detroit auto industry decreased from Q1 to Q2, as seen in Fig.1, it also lead to a decrease in the quantity demanded for the car parts, from Qd1 to Qd2 as seen on Fig.2. Due to the price drop from P1 to P2, the firms are now very likely to be operating at a position of loss4.

Price elasticity of supply (PES) is a measure of how much the supply of a product changes when there is a change in the price of the product. In the short run5, the PES of key car parts is very inelastic, but auto suppliers would not be likely to increase supply to try to save its market because the auto makers are also suffering from recession and by increasing supplies at this stage would only mean the total cost of productions will rise significantly, this would leave the poorly-performing auto suppliers no option but to temporarily shut down. Where in the long run6, the $700 billion bailout would help the auto makers to stay in business, then the auto supplier industry will adjust itself to a position where it’s operating at the point of normal profit7 by reducing the industry supply output from S to S1, which would lead the market price to go up to “P3” (see Fig.3).

When there is a significant drop in demand for new vehicles in the Detroit auto industry due to the recession, the quantity demanded for car parts in its local auto supplier industry has also decreased. The new equilibrium price in the long run indicates that the auto suppliers will adjust itself to a position where it’s operating at the point of normal profit.

  1. Demand is the willingness and ability of the people within a market area to purchase particular amounts of a good or service at a variety of alternative prices during a specified time period
  2. Supply is the willingness and ability of potential sellers to offer various specific amounts of a good or service for sale at each of a variety of alternative prices during a particular time period
  3. Equilibrium is the amount of output supplied equals the amount demanded. At equilibrium, the market has neither a tendency to rise nor fall but clears at the existing price
  4. Loss If total revenue is less than total cost, then we say that the firm is making losses
  5. Short Run is a time frame during which some inputs are fixed
  6. Long Run is a time frame during which no inputs are fixed
  7. Normal Profit is level of profit that enables continuation of economic activities
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