Economic Crisis Research Paper

Introduction

This research paper ill explore how the current economic crisis is affecting the market demand for automobiles in the U.S. American automobile manufacturers, especially the ‘Big Three’ – General Motors, Ford and Chrysler – were at the brink of bankruptcy in 2008 before a multi-billion dollar aid package from the government was secured. The major reason for this distress was falling demand.

It is of paramount importance to understand how the current crisis affects the demand for automobiles in order to make informed policy recommendations.        

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Literature Review

Economists have suggested a variety of models for explaining and forecasting demand for automobiles. However, there has always been a lot of contention among different scholars, since the heterogeneity of automobile as a good makes the task of explicating demand a complex one. Disaggregate choice model is suggested by Berkovec (1985) who suggests that short-run equilibrium can be achieved when supply equals demand for each make and model. Qualitative choice models, as described by Train (1985), based on the distinction between deterministic and random utility, is still frequently used by economists. The Independence of Irrelevant Alternatives (IIA) suggests that consumers first choose whether to purchase a car and the class of car, then the country of origin, and finally the specific model (Wojcik, 2000). Most contemporary researchers agree that the automobile should be viewed as a differentiated product, and demand for individual characteristics should be analyzed instead of aggregate demand (Bajic, 1993).

Research Objectives

This paper will look at how the current macroeconomic climate affects demands for automobiles in the U.S. It will discuss the applicability of conventional model for explaining and forecasting automobile demand under the current conditions. 

Credit Crunch and the Demand for Automobiles

Slowing demand for automobiles has been an indirect consequence of the subprime mortgage crisis. Consumers are distressed because of declining values of their properties or rising mortgage repayments.   

Unemployment (or a threat of unemployment) is another factor influencing the decision not to purchase an automobile. Moreover, more than a half of new automotive sales have been financed sales, mostly from home equity loans. Without such down payments, consumers find it increasingly harder to afford buying a car (Jones, 2007).

Demand has been slowing down not only in the U.S. but also internationally. There are very few countries in the world that managed to escape the effects of the global financial crisis. Weak demand globally puts additional pressure on U.S. automobile manufacturers, as the combination of decreasing overseas sales and increasing competition from foreign manufacturers in the domestic market appears to be a dangerous combination.  

Furthermore, the structure of demand has changed. Demand for new cars is slowing down more rapidly than for used cars; demand for luxury cars is falling more quickly than for economy cars. These findings are consistent with The Independence of Irrelevant Alternatives (IIA) which suggests that consumer choice of automobile is a three-stage process. First of all, consumers arrive at a decision whether they want to purchase a new car and also concerning the type of vehicle they want to buy (economy being the preferred one in times of crisis). Secondly, consumers decide on the country of origin of the vehicle. Given foreign exchange risks and shifting perception of reliability of domestic and overseas manufacturers, this factor plays a considerable role in shaping the demand for particular types of automobiles. Finally, consumers make a final decision about the make and model. The credit crunch mostly affects the first stage of the process, yet it also has an impact on the second stage as well.      

It is also important to keep in mind that the market for cars is highly heterogeneous. Such factors as income, indebtedness, and job expectations influence the decision to buy or not to buy cars.

One more reason influencing the demand for cars is expectations. While consumers might expect price to fall, they also anticipate erosion of incomes and job uncertainty, thus postponing the decision to buy a car for the distant future.       

Conclusion

It is of paramount importance to understand how the structure of demand for automobiles changes in times of crisis. While distressed consumers are less likely to spend, weakening aggregate demand results in decreasing industrial output and deepening crisis. Therefore, governments are encouraged to engage in countercyclical investment when economy is cooling.

Understanding demand is also important for car manufacturers if they want to remain profitable. Automotive sector in the U.S. generates millions of jobs and a lion’s share of revenues in many localities. The importance of automotive industry for the U.S. economy is hard to overestimate.

For automobile manufactures, especially for the recipients of government aid, the major challenge now is restructuring. They were criticized for not being reactive enough to the changes in demand. However, reacting quickly to changes in demand is a complicated task in the automotive sector. 

The main conclusion that can be made is that the current crisis will alter the structure of automotive industry as demand slows down and changes structurally.  

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