Thursday, November 20, 2008

A little economic theory

Ok, I’ve been thinking about this for a few days, too.


Consider basic, high school supply and demand models.


You have 10 companies who supply X number of items.

You have a market that demands Y number of items.


The market equilibrium will be met where the number Y meets the number X at a given price.  As price goes up, the demand line falls because, all things remaining the same, people will buy few of the same good if the price goes up.  As price goes down, the demand line rises because the reverse is true.


Meanwhile, when price rises manufacturers will want to produce more because, all things remaining equal, if they can make more per unit, they will want to produce more units.  When price falls the reverse is true because if manufacturers will get less per unit, they will want to make fewer units.


That creates a chart that looks something like an X and the center of the cross is the mythical equilibrium point.


Markets are rarely in pure equilibrium and there is usually some kind of surplus or shortage.


Ok, all fine and good.


Now take the same model and remove “all things being equal”.  If you remove a supplier, you reduce supply.  This doesn’t move you ALONG the supply line, this moves the supply line all together.  Demand, presumably, stays the same.  The equilibrium price goes up in the short term.  That’s basic market economics.


The thing that happens next, though, is what few people are thinking about now.  When the price goes up manufacturers want to make more.  Depending on current capacity limits, one of 2 things will happen:  current manufacturers will ramp up production (hire people) to meet demand or new entrants will begin production to meet demand.  Under both scenarios prices fall again because the supply curve shifts back to the right.  If new entrants come into the market (presumably from buying up the old manufacturing assets of those who go out of business) the price will likely drop faster than if old suppliers ramp up production, but either way the workers will be hired back (eventually) and production will continue. 


After all, people are still going to want to buy cars.  They’re still going to need to get to work.  They’re still going to need to replace their aging vehicles.  SOMEONE is going to have to build the cars that people are still going to need to buy…  unless the market contracts so much so that the former “Big 3” are simply “excess capacity” in the manufacturing system, which is also a possibility.


That all said, GM and Ford and Chrysler are not going to cease production.  Maybe cease production of SOME models, but they’re not going anywhere.  Bankruptcy does not make a company vanish into the winds.  Sometimes it makes them stronger.  One thing is for certain, continuing to be a poorly managed company is not a solution for these guys.


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