The Effects of Rising Oil Prices on the Automobile Industry

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The Effects of Rising Oil Prices on the
Automobile Industry
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Outline

• Veronica Kust- Short-term and Long-term Scarcity
• Bronwyn Ritchey- Substitutes, Elasticity
• Alex Puskar- Costs, Budget Constraints, Marginal
  Utility
• Marc Fillari- Externalities, Profit Maximization,
  Perfectly Competitive Markets
• Will Brown- Oligopoly, Cartels

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Short-term Scarcity

• The scarcity of oil available is slowly becoming
  insufficient to satisfy the desire for it.
• National oil companies are increasingly venturing
  beyond their home countrys borders in search of
  reserves.
• This causes an increase in the oil companies
  costs, which they pass on to the customers by
  raising the price of oil.

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Long-term Scarcity

• Since oil is scarce, it is necessary that new
  ways of fueling transportation are found.
• If oil runs out before alternative fuels are
  found, automobile companies will have no way of
  staying in business.

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Substitutes

• Ethanol
• Fuel Cell
• Hybrids

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Ethanol

• Made from corn in the US, can be produced from
  grain sorghum, wheat, barley, potatoes, and
  sugarcane.
• Can be combined with gasoline in any
  concentration to reduce consumption of petroleum
  fuels.
• Tolerance of ethanol depends on the individual
  vehicle
• Chrysler, Ford, and General Motors all recommend
  ethanol fuel
• Nearly every car manufacturer in the world
  approves ethanol blends in their warranty
  coverage.

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Ethanol

• Can be cheaper depending on where you live
• Midwest, it is almost 30 less per gallon
• West Coast, it is almost 35 cents more per gallon
• Contains less energy

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Fuel Cells

• Uses oxygen and hydrogen to produce electricity
• Ordinary air can be pumped in to be used for
  oxygen
• Storing hydrogen onboard is the problem
• Technology too expensive
• Needs multiple fuel cells, each costing around
  1,500
• Ordinary gas engine typically costs around 3,000

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Hybrids

• Two motors
• One is gas powered and the other is an electric
  motor
• Use an onboard battery that stores breaking
  energy and recharges itself when the battery is
  not being used.
• Cut emissions by 25-35 more than even the most
  fuel efficient gas powered model.

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Hybrids

• Most efficient of all cars
• 48 to 60 mpg
• Only 20-35 better than fuel efficient gas
  powered vehicles
• More expensive
• Cost between 19,000 and 25,000
• Similar gas saving cars range from 14,000 to
  17,000

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Elasticity of Demand

• In the short-run, demand for oil is relatively
  inelastic since the primary mode of
  transportation is cars that are fueled by
  gasoline.
• Therefore, any change in price is not going to
  have a drastic effect on the quantity demanded.

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Elasticity of Demand

• Although the demand for oil is inelastic in the
  short run, increased oil prices cause a decrease
  in the demand for new cars/trucks.
• In recent years, oil prices have steadily risen,
  while automakers have seen an increase in
  operating expenses and a decrease in sales.

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Price Elasticity

• Oil is price elastic in the short run
• Relatively small short-term supply reductions can
  translate into large price increases.

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Ford Motor Company

• 1999 Net Operating Income (in millions)
• Revenue- 135,073
• Expenses- 127,904
• Net Income- 7,169

• 2005 Net Operating Income (in millions)
• Revenue- 153,503
• Expenses- 169,596
• Net Income- (16,093)

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Implicit Opportunity Costs

• One opportunity cost we incur when we make the
  choice to use oil to fuel our automobiles is that
  we give up the opportunity of finding an
  alternative energy to use for our cars.
• We are losing money that could be used in
  research to discover better ways to use
  alternative fuels.

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Costs and Oil Prices

• Explicit Costs- Will increase to everyone except
  the oil companies.
• Short Run Costs- Will go up for certain business
  owners.
• Shipping companies, public transportation,
  trucking industries.
• Variable Costs- Will Rise in the short run.
• TVC, TC, AVC, ATC, MC

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Gas Prices and Marginal Utility

• The Consumer Equilibrium is going to be changed
  due to an increase in gas prices.
• Due to the higher prices, the marginal utility
  per dollar of gasoline if going to be less.
• The MUA/PAMUB/PB is going to be equal at a
  different number now, because of the change in
  gas prices.

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Budget Constraints

• The amount of gas a person is going to be able to
  buy at varying prices with a given income, is
  going to be less.
• So you will see changes in the slope and of one
  of the intercepts on budget constraint line.

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Gas Guzzling

• Given a gas budget of 40/week, a consumer could
  buy 40 gallons of gasoline at a price of
  1/gallon
• When gas prices go up to 2/gallon, that same
  consumer is only able to purchase 20 gallons each
  week without spending money that was intended for
  other uses.

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Other Issues Involving High Oil Prices

• Rubber and automobiles
• Sacrifices of other goods
• The change in Public Opinions

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Top 10 Things people Cut Down on
WHAT EXPENDITURES HAVE BEEN REDUCED TO PAY MORE
FOR GASOLINE "What products or services have you
cut back on?" Base Adults Who Cut Back on
Products or Services to Pay for Gas
Source http//www.harrisinteractive.com/harris_po
ll/index.asp?PID466

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Negative Externalities

• High oil prices have a negative externality on
  the economy.
• Since people are cutting back on spending in
  every aspect of their budget, the oil companies
  are the only ones who are making more money off
  the higher prices.

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Positive Externalities

• Gas powered cars negatively affect the
  environment.
• With the rise in oil prices, hybrids are being
  produced and are more environmentally friendly.
• Therefore, high oil prices end up causing a
  positive externality for the environment.

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Profit Maximization

• In any market, a firms profit maximizing rate
  of output is at the point where MRMC
• Firms costs are rising due to increases in both
  their explicit and implicit costs.
• This increase in costs makes it hard for them to
  earn an economic profit, even at their profit
  maximizing/loss minimizing rate of output.

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Profit or Loss

• Automakers used to be producing at point A which
  is earning an economic profit.
• Now they are producing around point C, an
  economic loss, because of the increased prices
  for their factors of production.

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Perfectly Competitive Markets

• In a PC market, profits are maximized at MRMCP
• If the automobile industry were perfectly
  competitive, they would only have to worry about
  their rate of output, since the price is taken as
  a given in a PC market.

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Oligopoly

• The automobile industry is an Oligopoly, and
  therefore must face a downward sloping demand
  curve

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Oligopoly

• There are barriers to entry in the industry.
• Economies of Scale
• Reputation
• Strategic barriers
• Legal barriers

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Imperfect Competition

• Too few car companies to be perfectly
  competitive.
• No standardized products
• Costly to enter or exit the industry.

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Non-price Competition

• Firms advertise to sell more of their
  differentiated product.
• The firms demand curve will shift.
• Car Companies advertising campaigns

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Advertising Campaigns
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Cartels

• Most extreme form of collusion.
• Organization of Petroleum Exporting Countries
  (OPEC).
• Drives up price of oil which affects automobile
  industry.

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Presented By

• Marc Fillari
• Will Brown
• Alex Puskar
• Veronica Kust
• Peter Florian
• Bronwyn Ritchey