Abstract
In the United States, the automobile purchase decision is consequential for both households and car producers. In households, adults typically own their own vehicles for personal use such as commuting to work or college. The need for multiple, safe cars per household represent a significant allocation of household income on an ongoing basis as old vehicles are replaced. Customer needs are represented by groups of demand utility functions which specify the demand for increasingly expensive safety features and styling changes. Auto manufacturers respond to the need for a variety of styles and safety features by producing vehicles in as many as 16 different product-market segments. They offer multiple financing options such as leases, late models, and stretching out payments to accommodate capital rationing by their customers. The quantity sold in each segment provides the profit per segment which adds across segments to provide the overall profit for the firm. This is a monopolistically competitive environment in which brand loyalty drives sales per segment, with each segment being considerably different from others in vehicle characteristics and customer income. This paper theoretically develops the demand utility functions within each segment, develops the producer’s profit function and then equates the supply and demand functions to obtain the optimal quantity per segment. Practical implications are discussed. One such implication is that the quantity of sales may not be realized in any one market, so that sales may have to be realized across markets for auto firms to achieve consistent, long-term profits. Thus, our quantity specification may provide a justification for the globalization of the auto industry.
Highlights
The foundations of classical capitalist economic theory were pioneered by Adam Smith [1], who viewed consumers as being engaged in the lifelong pursuit of betterment of their conditions
Dealers and manufacturers benefit from the higher prices received on new cars
The number of producers increased to the extent that monopoly prices could no longer be charged
Summary
The foundations of classical capitalist economic theory were pioneered by Adam Smith [1], who viewed consumers as being engaged in the lifelong pursuit of betterment of their conditions This goal was achieved by consuming goods that provided personal gratification. The new car producer has evolved from a monopoly to monopolistic competition, whereby there are many producers and many consumers, the product is differentiated and producers have limited control over price [6]. The purpose of this paper is to 1) theoretically model the utility functions that describe consumer demand in 16 product-market segments, 2) mathematically develop the production functions for producers operating in a monopolistically competitive environment, and 3) provide an explanation for dealer practices such as leasing, accepting trade-in vehicles, selling last year’s vehicles and extending payment periods. The producer position has been examined from the standpoint of consumer rebates [13], lemons [14] and consumer loans [15]
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