Economics Coursework - Demand

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Manufacturers and dealers want UK to follow Europe into scheme to give cash to drivers who scrap old cars to buy new

The government was facing renewed pleas to bail out Britain's ailing motor industry yesterday as figures showed sales of new cars had dropped by almost a third year on year.

Only 313,912 cars were registered in March - a 30.5% fall in sales from this time last year, figures from the Society of Motor Manufacturers and Traders (SMMT) showed, prompting fresh calls for the government to pay motorists to trade in their old cars for new ones.

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The motor industry and lobby groups are hoping this month's budget will include a scrappage scheme, under which car owners are given a financial incentive of about ï¿½2,000 to swap their old vehicle for a new greener model.

Treasury officials have told the industry they are seriously considering including such a stimulus in the budget a fortnight tomorrow although ministers publicly insist that no decision has been taken.

A scrappage scheme in Germany - which offers car owners ï¿½2,500 (ï¿½2,263) for getting rid of any vehicle over nine years old - has attracted more than half a million buyers, with sales soaring 40% there in March.

The SMMT estimates that 280,000 Britons would take advantage of a similar programme over an 18-month period. This would cost around ï¿½560m, a figure the SMMT told the Guardian would involve a net cost of ï¿½150-160m. The rest of the money would come from the VAT charged on new cars.

But green groups counselled against such a "knee jerk" response and said the money could be better used to fund sustainable transport solutions.

Some environmental organisations fear funds could be diverted from existing pots of money set aside by the government for investment in green technologies, such as the ï¿½400m earmarked in the pre-budget report for an "environmental transformation fund", which supports the development of new low-carbon energy and energy efficiency technologies in the UK.

Pro-motoring lobbyists argue that if the government does not move quickly to boost the industry, further jobs would be lost and some manufacturers may transfer their business to other countries.

In Whitehall, the debate is still swirling over the wisdom of adopting a "scrappage" scheme. Lord Mandelson, the business secretary, said in February that his department was examining the experience of other countries, notably Germany, to see whether it would work in Britain and carmakers were asked to produce costed proposals, but no decision has been made.

David Cameron told the Guardian in January that the Tories were looking at the idea but he was yet to be convinced.

In the meantime, demand for cars has crashed across the world, throwing the global industry into its biggest crisis and forcing American giants General Motors and Chrysler to the brink of bankruptcy. Manufacturers in the UK have also been hit, with factories such as Honda's plant at Swindon mothballed and thousands of jobs cut.

Last month's decline in sales follows falls of 30.9% in January 2009 and 21.9% in February. March, when new number plates are issued, is a key period for the industry and traditionally accounts for nearly a fifth of annual sales. If things do not improve, the SMMT is forecasting that only 1.72m new vehicles will be sold in 2009, compared with 2.13m in 2008.

However, there was one bright note with the rise of the small car segment, where sales increased 84%, indicating a trend towards downsizing among consumers. The top three best-selling models were the Ford Fiesta, Vauxhall Corsa and Ford Focus.

Yesterday SMMT chief executive, Paul Everitt, said: "March new-car registrations are a barometer of confidence in the economy, from businesses and consumers alike. The fall in the market shows that the government needs to do more to boost confidence.

"A scrappage scheme will provide the incentive needed and the evidence is clear that schemes already implemented across Europe do work to increase demand. The UK is the only major European market not to implement a scheme."

Edmund King, the president of the AA, said: "The latest figures show the stark difference between a country with a scrappage scheme and one without. A vehicle-scrappage scheme has the potential to reduce emissions, reduce accidents and their severity whilst giving a boost to the UK motor industry. There are many benefits from getting older gross polluters off the road."

But green groups counselled against introducing such a scheme. Peter Lipman, policy director at Sustrans, the sustainable transport charity, said it would be "a really, really bad idea, wherever the money is coming from". "There are so many better ways of spending government money if you are trying to deal with both the recession and climate change," he added.

The RAC motoring strategist, Adrian Tink, said: "The introduction of any car-scrappage scheme needs to be contingent on balancing the economic benefits with a concern for the environment. The scheme needs to be as much about getting old, high-polluting cars off the road as it is about stimulating car sales."

The dire sales figures bode ill for the economic recovery because new car sales are seen as a key indicator of consumer confidence.

When the UK went into recession in the early 1990s, new car registrations dropped for 27 successive months. At one point, sales that had reached an annual peak of 2.3million in the late-1980s dipped as low as 1.5million.

IB Economics: Internal Assessment Commentary

Car industry begs for budget boost from Alistair Darling

The article "Car industry begs for budget boost from Alistair Darling" found on the web page of The Guardian discusses the effects of the current recession on the car industry, particularly in the UK. The article states according to the SMMT a 30 % fall in sales from the year before at the same time. In order to take a first step to solving the problem the motor industry hopes to impose the scrappage scheme..

The drop of demand for cars during the recession creates an example of the laws of demand and supply. Demand is the quantity of a good or a service that consumers are willing and able to purchase at a given price in a given time period. Supply is the willingness and ability of producers to produce a quantity of a good or service at a given price in a given time period.

Consumers being aware of the recession will rather save their money than choose to spend it on luxury purchase. The fall in income due to the recession has, according to the laws of supply and demand and assuming that all other things stay equal (Ceterus Paribus), caused the fall of demand.

Although the article doesn't state a percentage of the fall in income of the population, the income elasticity of demand for vehicles can be described as at least unitary if not elastic, the examples will make an attempt to prove this.

Income elasticity of demand measures the proportionate response of quantity demanded to a proportionate change in income.

The article gives two proves for that: First, the thought of the coming recession has already let people stop buying cars by 30.5% from one year to the other. People won't buy any luxury goods in bad times. And second, subsidising car buyers by about 2000ï¿½ (scrappage scheme) will increase the purchases in a month by 40%.

The fall in demand will also cause an excess supply even if the motor industry stops production directly. All car producers will hence have a massive amount of cars that are just not being bought because there is no demand. According to the rules of supply and demand, as demand falls, quantity supplied decreases as well. In this particular case, the quantity supplied decreases as well but probably not as much as it could to find a new equilibrium, the price at which supply equals demand. Why this is the case will be explained after the following

The following graph will show how a fall in demand will cause the demand curve to shift to the left and therefore a fall in the quantity supplied of cars to find a new equilibrium. It can be seen that cars sales fell by nearly 25 % from 2008 to 2009

As stated above, this development is not quite that what happens in reality. According to the rules of unemployment, unemployment is a lagging factor and the demand for labour depends on the demand for, in this case, cars. That means that it begins to rise some time after the recession began. This is because of several reasons such as that firms want to keep skilled workers and will delay redundancies hoping that things might get better. Since firms want to keep skilled workers they would have to keep up the production to a certain extend. Of course production will decrease what will cause cyclical employment but to a certain extend production will be kept up to occupy the workers.

The term cyclical unemployment can be defined as occurring when the economy is growing more slowly than estimated as the demand for labour is interdependent on the demand for goods and services.

This situation can't be kept up for long because firms lose money spending more money on workers they try to keep than actually gaining through sales and go bankrupt if the recession doesn't end or if they are not being subsidized by the government.

Hence the motor industry searches for ways of pushing demand. A possible solution could be the scrappage scheme which encourages motorists to swap their old cars against new ones by giving the buyer about 2000ï¿½ directly.

The effect of the scheme on the demand for cars can be seen on the following diagram:

Demand rises again due to the encouragement and shifts the demand curve to the right again.

Concluding one can say that the law of supply and demand is displayed in the real world. In the article "Car industry begs for budget boost from Alistair darling" it is clearly shown how recession can affect the demand for cars and how therefore demand for labour interdepends on demand for, in this case, cars. Furthermore it can also be stated that things like the scrappage scheme can encourage demand again.