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16.5 End-of-Chapter Material

In Conclusion

When you study economics from a textbook such as this, you learn different economic theories. In this book, we have looked at the theory of the consumer, which helps explain how individuals make their choices about what goods to buy. We have looked at the theory of the firm, which explains how firms make decisions about which goods to produce and what price to sell them at.

Our goal in this book is to help you see that economics is not only a matter of graphs and definitions but also the study of the world around you. Economists see economic decisions and economic forces everywhere they look. This chapter gave you many examples linked to one particular and very familiar product. Yet we have only scratched the surface in terms of the ways in which we could apply economic analysis to cars and the car industry.

Perhaps you can think of other ways in which you could apply the things you learned from your study of economics to the market for automobiles. In any case, we hope that, now, every time you see a car, you will remember that you are also seeing economics in action.

Key Links

Exercises

  1. (Advanced) A car is an asset, like a house. How would you use the principles of asset valuation to ascertain the value of a car? (Hint: see Chapter 9 "Making and Losing Money on Wall Street".)
  2. List the products and/or services that are substitutes for cars.
  3. Because a household can delay the purchase of a new car when the price increases, what does this do to the price elasticity of demand for cars?
  4. List the car characteristics and household characteristics that would increase a household’s valuation of a car.
  5. Would an increase in the price of gasoline decrease the demand for all cars or only some? What are the effects of an increase in gas prices on alternative forms of transportation?
  6. In the coordination game for automobile insurance, is it desirable for the government to require that everyone buy automobile insurance?
  7. There are three people in a community. The government is proposing to build a bridge in that community. The bridge costs $120 to construct. Everyone values the bridge at $60. Is it efficient to build the bridge? Suppose the government asks people what the bridge is worth to them and plans to tax them the amount that they say. If two people truthfully reveal to the government that the bridge is worth $60 to them, will the third person give his true valuation as well?
  8. Using the equation linking the price of a car to markup and marginal cost, if the markup is 60 percent and marginal cost is $20,000, what is the price? Show with this example that a firm facing a more elastic demand curve will set a lower price.
  9. Is a car dealership more valuable in a small city with little competition or in a big city with more competition but also more potential buyers?
  10. Car dealers make profits from goods and services that are complementary to the cars they sell. List and discuss some of these complementary products.
  11. Why do automobile companies offer warranties with new cars? Why do these warranties expire after a few years?
  12. What factors determine the choice of an automobile producer to create a new model?
  13. If you were a seller of a used car and you knew it was high quality, would you have an incentive to offer the buyer a warranty on the car? Would you have that same incentive if you knew the car was low quality? What then should you as a buyer infer if you see a seller willing to offer a used car with a warranty?
  14. One concern with opening markets in the United States is that domestic car producers are forced to compete with foreign producers. In some cases, this competition leads to job losses in the United States. Who gains from this competition?
  15. (Advanced) If you were designing a policy of charging for road use, would you include or exempt taxis?
  16. In what sense is buying a car like buying health care? What do car companies do to provide buyers with assurance over the functioning of the car? Why doesn’t this happen in the health-care market?
  17. If you look at the market for cars, high-income households are more likely to buy new cars, and lower income households are more likely to buy used cars. Why is that the case?
  18. Following a recession, it is likely that the average age of cars will be higher than prior to the recession. Why?
  19. Would you say that the market for higher education is a market with monopolistic competition or a monopoly? How does competition occur in that market?

Economics Detective

  1. In addition to car production being shifted to the southern part of the United States to reduce labor costs, car production has also moved overseas. What information can you find on the wages of workers at automobile plants outside the United States?
  2. What is the current penalty on companies that do not meet the CAFE standard?
  3. In June 2009, the US government became a majority owner of GM. What prompted that action? Why did the US government not buy Ford Motor Company? What has happened to US government ownership of GM? What has happened to the sales and profitability of Ford and GM in recent years?
  4. What products other than cars have a “model year”? Are new models introduced simultaneously or at different times of the year? What factors might determine the timing of new model introductions?

Spreadsheet Exercise

  1. Based on the equations for markup pricing, create a spreadsheet to calculate the price you would set as a car producer. To do this, input the elasticity of demand and marginal cost. Use your program to calculate the markup and product price. Produce graphs to show how the product price will change as the elasticity of demand changes.