Question

Automobile manufacturing is an industry subject to significant economies of scale. Suppose there are four domestic auto manufacturers, but the demand for domestic autos is no more than 2.5 times the quantity produced at the bottom of the long-run average cost curve. What do you expect will happen to the domestic auto industry in the long run?

Answer 1

In 1970s, USA faced several economic issues in the field of automobile industry. Due to high competition from industries of foreign countries and increase in the price of oil to used in automobile industry, the industry of USA was affected much. Later, the industry picked up. But, in the year 2008, again USA automobile industry fall into same issues. Automobile industries usually expand their production to a large scale. Then they should concentrate not to make an increase in cost as it will lead to diseconomies of scale.

When production increases, fixed cost will be allocated to a higher volume of output. Variable cost per unit and fixed cost per unit will decline and thus the production efficiency will increase. This shows economies of scale. But whenever, the output goes beyond a particular limit of output, then the average costs will rise. It may lead to dis economies of scale.

And, when demand is reducing and the actual output couldn't be sold due to various issues, the firm may not survive in the long-run. The reduction in demand may be due to demand for foreign automobiles or increase in fuel price or lack of quality or efficiency.

According to the question, there are four domestic auto manufacturers. As the demand for domestic autos is not greater than 2.5 times the quantity produced at the bottom of the long-run average cost curve, any one of the four firms will not exist in the long run. Also, at least any one of the four firms will be striving to face such a difficult situation.

Answer 2

Answer:

Due to economies of scale, the domestic auto industry will consolidate in the long run.

• Current State: 4 manufacturers producing at inefficient scales.

• Problem: Demand is only 2.5x the optimal scale (bottom of LRAC curve).

• Outcome: Fewer firms (likely 2-3) will survive via mergers/exits to operate at minimum efficient scale.

• 
  

• Result: Lower costs, higher efficiency, but reduced competition.

• 
  

Final Industry Structure: Fewer, larger automakers dominate