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Eco 301 - Economic Overview of the Automotive Industry

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Economic Overview of the Automotive Industry

Western International University

ECO 301 Economic Theory

The automotive industry is without a doubt an industry that has massive implications relating to the United States economy as well as affecting every American household. Shifts in the supply and demand of automobiles influence the current and future household purchases. Households must determine what amount of their hard-earned income to allocate to certain necessities. Because most households have a budget, the amount spent on transportation it limited. While most industries have an effect on the economy, the automotive industry has far-reaching implications for most Americans. Not only are the workers affected but the many spin-off jobs created as well as the consumers that must purchase the automobiles manufactured.

The automotive industry is considered elastic. The prices fluctuate depending on supply and demand. For example, when the economy takes a downturn and car sales are down the automakers attach incentives to the purchase of new vehicles to stimulate sales such as interest-free loans, rebates and lowered prices to encourage Americans to purchase their goods. Substitutes are available in the foreign car market. Lower cost, more fuel efficient models are available from many foreign car makers. Policy makers have placed limits on the amount of foreign cars that can be sold in the United States but in recent years the demand is higher so policy makers must respond to that demand. Past statistics tell the story of when fuel prices surge, smaller fuel efficient cars are more in demand. Higher fuel prices cause households to reallocate money from other areas to purchase fuels at higher prices because fuel is needed for transportation to and from work. When fuel prices are higher households begin to cut back on unnecessary trips. Cars are unique in that they are both a necessity and a luxury. Few American households live without some form of transportation. The amount of money spent on the transportation proves whether the automobile is a necessity or a luxury. Higher priced models sell more when the economy is stronger. When the economy is slow lower cost cars are more popular. Transportation as a whole is a necessity. The form of the transportation is what determines if it is a luxury. (Collier, 1981)

The fluctuations in the supply and demand of automobiles have an effect on other industries. One such industry that is affected in a measurable way is the after-market automobile parts industry. When the demand for new automobiles is high the demand for after-market parts is lower. When the demand for new automobiles is low the demand for after-market parts rises. The only explanation is uncovered when looking at individual households. Individual households have a limited amount of money to budget for transportation. If new cars are in high demand the income is higher for individual households. If new cars are not in high demand individual households have less money to budget for transportation. With less money to budget for transportation, individuals are more likely to use after-market parts to make repairs on their existing vehicle rather than purchase a new vehicle when their current vehicle needs costly repairs. The cost to repair a vehicle is far less than the cost to purchase a new vehicle. (Lamonica, 1995)

The automotive industry produces public goods and common resources. For example police and fire rescue vehicles are common resources used for the good of the public. In the situation of police and fire rescue vehicles, they are rival but not excludable. The resource being excludable means that if the fire truck is at one persons house it prevents the truck from being at someone else's house. The availability is diminished because it is being used by another person. (Mankiw, 2004)

If the automotive industry is looked at from the passenger car aspect, the industry produces private goods that are excludable and rival. The owner can prevent another person from using the vehicle and the owner's purchase of the vehicle prevents the purchase of that vehicle by another person. (Mankiw, 2004)

The issues of the automotive industry create both positive and negative externalities. On the positive side, the automotive industry creates and externality of an improved economy. Many people benefit from the jobs that are created as well as the benefit of efficient transportation. When the automotive industry is strong there are many spin-off jobs created such as, parts suppliers, restaurants, and other service industries. Not far from where I live a large automotive plant was shut down permanently. The many businesses that were built up around the operation of that plant were affected and are now facing the same fate. On the negative side, the pollution created from the production as well as the operation of automobiles creates an externality. (Smith, 2001) While pollution is not desirable many are willing to accept a certain amount of pollution with limits placed by policy makers so the benefits of the automotive industry can sustain.

While wage inequality most likely exists across all industries, the automotive industry is no exception. The demand for newer designs and options on automobiles has introduced the need for companies to become more competitive by using the aid of technology. The automotive industry has a history of higher than average wages resulting in fewer turnovers than many industries. This causes an aging workforce that is not educated in the area of computers and automated controls. (Wheeler, 2005) To remain on top each company in the automotive industry strives to continually offer something new and different. Each company must continue to evolve and the most efficient way is by using new technologies. When an aging workforce has a difficult time with or refused to learn new technology automobile makers must find a way to deal with this issue.

Recently the industry has felt the blow of the collapse of the automotive parts supplier, Delphi Corporation. Companies such as Delphi have created some of their own problems by allowing wage inequality get out of control. There is no doubt that worker's unions have contributed to the wages being out of control. A recent article from the Nightly Business Report states that the average wage at Delphi was $65 per hour. This contributed to the collapse of the company as they were not able to maintain that level of compensation. (Gersh, 2005) While the automotive industry attempts to compete in the global market, the competition from countries like China, where the workers average 50 cents an hour, creates an inequality in the wages that are



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