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Econoception 2014

Econoception Issue 35: 12th October 2014

Table of Contents

1. Micro: Europes Automobile Industry

2. Macro: Chinas Productivity

Bonus Video:
http://goo.gl/cI1DXE

Link to download mindmap:

goo.gl/a4LcqK

EUROPES AUTOMOBILE INDUSTRY

1. Polishing up Europes carmakers
http://www.economist.com/news/business/21623695-cheap-cars-are-not-selling-so-their-makers-are-bettingexpensive-ones-polishing-up

The Economist Oct 11th 2014 Print Edition

Content from H2 Economics being applied:

Everything in Micro
This is a great article to practice thinking about demand and supply
concepts. Car sales in Europe have been falling every year since the
financial crisis in 2008. What's going on?
Sales = equilibrium price * quantity. I don't know for sure but my guess
is both are falling especially quantity. Demand probably accounts for a
large part of the fall.
As cars are mostly luxury goods, falling incomes in Europe due to the
drawn out recession in many countries means that demand for cars have
fallen quite a bit. The precise term would be "more than proportionately"
compared to the change in income. The recent sanctions imposed on
Russia over Ukraine make matters worse for car-makers.
But the really interesting part of this article is the following paragraph:
"Even after six years of falling sales, carmakers have not done enough
to cut their excess capacity in western Europe. Haroon Hassan of
Mitsubishi UFJ, a bank, reckons that together, their assembly lines are
turning out just 65% of the 21m cars a year they could make at full tilt.
Analysts reckon they need to run at 70-80% just to break even."

Why are firms not responding to price changes? Why are they giving
up on profits?
First, firms may be irrationally optimistic about the future. I say irrational
because their beliefs may not be backed up by facts. Closing down
factories and production lines are difficult decisions to reverse and would
make firms look like fools if the market rebounded just when they cut
supply.
But this irrational optimism can be very damaging because there is a huge
opportunity cost to waiting. Each period of delay will mean more incurred
losses.
Second, there are significant barriers to exit and factor immobility that are
preventing firms from restructuring. Yes, this is market failure and it
causes inefficiency and deadweight loss.
Most firms' strategy now is to compete in the upscale luxury market. But
that's going to be difficult because the established brands -- Volkswagen's
Audi and Porsche, BMW and Baimler -- are not going to be easy to topple.
Brand-conscious consumers do not switch easily. Things may get worse
for the automobile industry.

CHINAS PRODUCTIVITY
1. The woes of the average Joe Barack Obama and
the economy
http://www.economist.com/news/finance-and-economics/21623708-weakening-productivity-casting-doubtsustainability-chinas

The Economist Oct 11th 2014 Print Edition

Content from H2 Economics being applied:

Productivity
Efficiency

How do you measure productivity? One way is through labour

productivity: total output / size of employed labour. But this may not be a
good measure of actual productivity because adding to the capital stock
automatically increases it.

So economists have asked -- is there a way to measure productivity while

separating out the effects of having more inputs. In other words, how do
we measure how well inputs are being utilised in the production process?
A measure that was created in 1957 called the Solow Residual measures
the Total Factor Productivity (TFP).

This is not in your syllabus, so just know that this is a measure of

productivity. More importantly, what does this measure tell us about
China's growth? According to the researcher cited in the Economist article,
China has been having negative TFP growth in the past decade.



But I would take this finding with a pinch of salt because he did not use
the official Chinese statistics as he thought they were unreliable. Instead
he constructed his own measure of GDP and capital, labour stock and
used those to produce his research.

However let's suppose it were true. What does it entail for the Chinese
economy? It means that growth so far has been based on amassing more
labour and more capital instead of making better use of the available
resources. In fact, negative TFP growth figures mean that the economy is
becoming more inefficient.

TFP as a Window to Microeconomics

It means that firms are not productive efficient and resources are being
allocated to the wrong sector. A negative correlation was found between
productivity and the amount of bank lending. Could this suggest that
banks are channeling money into the wrong sectors?

Most of China's productivity gains in the past were from reallocating

labour and capital from farms to factories and from state owned firms to
private enterprise. Factories employ more sophisticated production
technology and generally produce goods that are valued higher in the
economy this naturally adds to output and productivity. State owned
firms in China tend to be more inefficient because of bureaucratic and
corrupt practices.

Moving ahead, China has to look at how she can improve technology and
infrastructure, as well as better educate her workforce. Better governance



and less state intervention in the financial markets may help too. Much of
the world's growth depends on China.