During the early 1980s, the US auto industry was dominated by three domestic players, Ford, GM, and Chrysler. The import of cars into the US market was relatively less. The market penetration was relatively high in the car market. However, things started changing when the Japanese companies started exporting cars to the US market. In the first half of the 1980s, the market share of Japanese cars in the US market increased manifold. The market share from 17% in 1980 grew to 25% within a few years. Due to the increase in demand for Japanese cars, the demand for the American cars went down. Due to this, a large number of United Auto Workers lost their jobs became unemployed. All the three big auto manufacturers of the USA announced huge losses. In order to compete with the Japanese auto manufacturers, the US automobile companies requested the International Trade Commission (ITC) to create an import quota on Japanese cars. This essay will discuss the US auto market, do a demand analysis using different elasticity models, and finally, will touch upon how different stakeholders view the situation differently in this market condition.
The US Auto Market Equilibrium and Elasticity of Demand
Diagram 1: 1) Perfectly Elastic Market and 2) Perfectly Inelastic Market.
In a perfectly inelastic market, there is no demand sensitivity of price changes. In a perfectly elastic market, there is no price sensitivity of demand changes. The US market was neither of the two during the 1980s.
Till 1970s and the early 1980s, the US auto market was dominated by a few numbers of players. The market penetration of automobiles was very high. The price of the American cars and the customer demands were at equilibrium as there was not much variation in price. However, with the appearance of the Japanese cars into the US market, customers got an option to get cars at low cost.
Diagram 2: US automobile market during 1980s (relatively inelastic demand curve)
In a relatively elastic market, as the price of a product goes down, the demand for that product goes up by a lot (Hofstrand, 2007). This was not the case, however, in the US car market at that time. In fact, the US car market was relatively inelastic with the total demand for cars increasing slightly with a price drop. In a relatively elastic market, the introduction of Japanese cars would have increased the overall demand of cars in the US market, which did not happen in the USA. Rather, the Japanese cars replaced the demand for the American cars. As the input cost of producing a car for the US manufacturer was higher than that of the Japanese manufacturers, even if both sold their cars at the same price, the US manufacturers would have been on the loss. If this condition lingered little longer, then the US manufacturers would have gone out of the business. However, the overall demand for cars increased in the latter half of the 1980s, making the price elasticity more elastic.
Market Dynamics and Regulations
In a perfect market condition, the US cars in the 1980s were unable to compete with Japanese products. Japanese cars were not only cheap, but they were also perceived as high-quality and high-performance products. We could say that the imported cars from Japan were operating in a monopolistic market because of their unique product features (quality, cost and durability). Therefore, the market demand shifted from the American cars to the Japanese cars within no time. This created financial distress to the US auto manufacturers and increased the unemployment rate. The only way the US auto manufacturers could have survived that market was by creating a barrier of entry either through an import duty or through an import quota. The introduction of an import quota would have ensured that the market share of the Japanese cars would not go up beyond a certain percentage, and the customers would have no other choice but to buy cars made in the USA. In this scenario, only a few customers would have benefited by buying the Japanese cars, which were of high quality but low cost. However, most of the customers would have been forced to buy the high-priced, low-performing US made cars, or would have delayed their buying decision, which would have reduced the overall demand. In this scenario, the manufacturers would have gained, but the customers would have suffered.
Diagram 3: Impact of Tariff on the price and quantity
Imposing an import tariff on the Japanese cars would have made the US manufacturers more competitive against the Japanese manufacturers as the price difference between the US and Japanese cars would have diminished. However, Japanese cars would still be more in demand because of their superior quality. In that case, the US manufacturers would not have lost their market share easily in the short term, but if they did not improve their quality, eventually they would. However, this situation is non-beneficial for the customers. Even if the Japanese cars were actually available at lower prices, because of the imposition of this import tariff, customers needed to pay more for buying that car. In this scenario too, the US manufacturers would have gained at the expense of the customers.
Import Quota and Price Fluctuations
Diagram 4: Impact of Quota on Imported Cars: Short term demand curve shift and long term supply curve shift
The introduction of mechanisms like import quota and import tariff creates inefficiencies in the market equilibrium due to which some of the players remain in a more advantageous position than the others (Copeland, Dunn and Hall, 2005). In this case, when ITC introduced an import quota of 1.68 million units for the Japanese cars a year, it provided the American automobile companies with an unfair advantage in the US market. The Japanese companies agreed to this quota arrangement because of political reasons, but ultimately, it is the consumers who suffered. As we know from the standard market equilibrium theory that whenever there is a quota on the market, the price goes up due to more unmet demands in the market. The price, in this situation, increases till that point when the total quantity demanded for the Japanese cars becomes equal to the quota.
Diagram 5: Impact of Quota on Imported Cars
During the three years of quota regime in the USA, the average price of the Japanese cars increased by $1,000 due to the imposition of quotas. From the above diagram, it can be seen that due to the imposition of quotas, after reaching the final equilibrium, Japanese cars were losing money equal to the blue square shown in the diagram. On the other hand, when the Japanese companies started selling cars at a higher price, they started making more money equal to the green box in the above diagram. If the green box is bigger than the blue box, then the Japanese companies were making more money after the imposition of quotas, and if not, then they were losing money. This depends on the slope of demand and supply curves.
Import Quota versus Unemployment
The decision of introducing quota by the US government was not an easy process. It was estimated that because of the entrance of the Japanese cars into the US market, 193,000 UAW employees lost their jobs. On the other hand, imposing a quota on the Japanese cars would have made the consumers pay thousands of dollars more for the same kind product. The average price paid by the consumers was more than $1,000 and the annual quota was 1.68 million cars. In three years, the consumers would have paid $1,000 x 1.68 million x 3 = $5.08 billion. Before arriving at a decision, the US government had to take into account the sufferings of the American auto workers and the auto companies and economic impact of the quota measure on the customers. However, this does not give the total impact of the quota as there is also a multiplier effect of the quota. The tighter the quota, the less new cars will be available in the market, and also less cars in the resale market. Therefore, for a more accurate calculation of the customer impact, it is important to understand and apply those parameters as well.
In a separate study, it was found that the cost impact of per job saved by the quota measure was $160,000. Assuming that the imposition of quota made sure that the 193,000 workers (in 3 years), who lost their jobs, got their jobs back, the total economic impact is calculated to be $160,000 x 193,000= $30 billion.
Therefore, it seems that the imposition of quota for a temporary period (3 years) was a rightful decision by the US government at that time as the economic impact on the jobs was more than customer price impact.
In this market condition, there are four main stakeholders; the government, the US Auto manufacturers, the US Auto Workers (UAW) and the Japanese car manufacturers. In this market scenario, Japanese car manufacturers, despite creating the main market equilibrium shift, were the players who had no voice in changing the market equilibrium conditions.
The US auto workers were only concerned about their jobs. Imposing quota would have protected their jobs. However, the UAW knew that importing quota was not a long term solution and they would eventually lose their jobs. Therefore, they wanted the government to introduce policies to ensure that more manufacturing was done on the US soil. One of the ways to do it was to introduce a law that more than 70% of the parts assembled in a car should be manufactured in the US. If that was introduced, then even the Japanese manufacturers would have been forced to establish manufacturing sites in the US soil for the cars and car parts. This would have ensured the creation of many jobs. Three years of quota and political pressure accelerated the process of Japanese manufacturers establishing car plants on US soil.
However, introducing a law like the above would have increased the input cost for the US manufacturers. All the US manufacturers were manufacturing or procuring parts from different parts of the globe. Therefore, the US automakers were keener on other measures like the import quota or import tariff for a temporary period, which would have given them enough time to improve their production process so that they could compete better with the Japanese cars when the quota would be lifted. For example, the Dearborn plant of Ford with a heavy investment could have improved the productivity and quality significantly within the next few years. For example, $650 million will be invested by Ford which would improve the productivity by 25%. That means that the same use of resources (equipment, machinery and personnel) would begin to produce 25% more cars or car parts. The average cost per unit of the car will come down. However, this process will take some time and imposing quota for 3 years will provide the much needed time for not only Ford, but for all the US based manufacturers.
The US government and ITC were more interested in fair trade practices and balancing between different stakeholders in the market. The US government was in a dilemma between introducing a quota arrangement (for protecting manufacturers), a law on producing 70% of the parts on US soil (protecting the UAW) and the increased cost for the customers. Finally, they introduced a 3 year volume quota on Japanese car import. This helped the car manufacturers directly, and since the Japanese car manufacturers started creating manufacturing plants in the USA, it also helped the UAW.
The US auto market in the early 1980s was a perfect example of market equilibrium and the effects of product substitute and regulations on the price and quantity demanded. In a perfect market in the early 1980s, Japanese players were selling a better product at a cheaper price. Therefore, they were substituting the US auto products. However, after the introduction of quota by the US government, the US car makers were able to sell their cars at a higher price as the total demand was relatively inelastic at that time. Also, it helped the UAW as the unemployment level was contained at a low level. However, due to the quota introduction (demand ceiling), the price of the product (the price of the imported cars) went up. This case shows clearly how the market equilibrium shifts due to changes in different market parameters.
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