Assignment Economics MicroEcons for LKW MBA

8/8/2019 Assignment Economics MicroEcons for LKW MBA

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Introduction

In Economics, numerous factors, policies, or issues will affect a supply of a product

or service to either decline or increase. This is especially evident in microeconomicswhere the Law of Demand states that,

“When other things are equal (ceteris paribus), the quantity demanded of a

good falls when the price of the good rises.”

What the above statement is trying to say is that microeconomics deals with a

branch of economics that examines the functioning of individual industries and the

behavior of individual decision-making units, that is, business firms and households.

In this paper, I will concentrate more on the impact of certain issues on households

as it is easily more relatable to the readers of this paper for easier understanding. I

will try to critically examine the impact of decline and increase in household income

on the sale of new passenger vehicles in the United States of America.

The current issue I have chosen is the “2007 US Economic Recession” and how its

impact on Household Income has significantly decreased purchases of new

passenger vehicles and afterwards, I will also briefly mention the steps that were

taken by the American Government to counter this decline via its “Cash for Clunkers”

Program.



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The 2007 American Recession

The financial crisis of 2007 has been called the worst financial crisis since theAmerican Great Depression by leading economists (Dean barker, 2009), and it

contributed to the failure of key businesses, declines in consumer wealth i.e. income

estimated in the trillions of U.S. dollars, substantial financial commitments incurred

by the government, and a significant decline in American economic activity. Many

causes have been proposed, with varying reasons given by experts. Both market

based and regulatory solutions have been implemented or are under consideration,

while significant risks remain for the world economy due to America’s nature as aleading Economic superpower.

Due to the direct relationships between declines in wealth, and declines in

consumption, Americans had to reduce their spending as threats to their job security

and future income increased. The American unemployment rate jumped to 9.5%, an

increase of twice the percentage before the recession. With the American population

at 250 million, there are 23.7 million individuals unemployed. To put that into

perspective, that is more than the ENTIRE population of Malaysia, without work.

This is not the first time America has suffered a recession, below is a chart showing

the years America has suffered a recession.

The number One (1) represents the “good economic years”, and the Zero (0)

represents the years suffered by recession.



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What is Income?

Income is the consumption and savings opportunity gained by an individual or

business within a specified time frame, which is generally expressed in monetary

terms (N. Barr, 2004). However, for households and individuals, "income is the sum

of all the wages, salaries, profits, interests’ payments, rents and other forms of

earnings received in a given period of time” (Case & Fair, 2007).

Hence, income is tied directly to an individual’s ‘earning power’, without work or

employment; expenditure will drop due to a lower ‘spending power’ as more and

more people will opt to save whatever assets they may have to weather out the

storm of this economic recession.

Below is a chart of the median income earned by Americans from 1967 till 2008 as

well as a table giving the individual years’ median income on the following page.



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American Household Income

Year Median Income

1970 43,219

1971 42,798

1972 44,632

1973 45,533

1974 44,091

1975 42,936

1976 43,649

1977 43,925

1978 45,625

1979 45,498

1980 44,059

1981 43,328

1982 43,212

1983 42,910

1984 44,242

1985 45,069

1986 46,665

1987 47,251

1988 47,614

1989 48,463

1990 47,818

1991 46,445

1992 46,063

1993 45,8391994 46,351

1995 47,803

1996 48,499

1997 49,497

1998 51,295

1999 52,587

2000 52,500

2001 51,356

2002 50,756

2003 50,711

2004 50,535

2005 51,093

2006 51,473

2007 52,163

2008 50,303



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How the Recession has Changed Consumer Spending Behaviours

The impact of the recession has had on American consumers and how it’s changed

their behaviour as a society will be with the Americans for a very long time.

As can be seen in the table below, the expenditure on goods has declined by 3.2%

from 2007 till 2009 with spending in vehicle related matters declining by 1.1% less

for new vehicle purchases and 1.3% less spending on gasoline. With the recession,

the industry hit the hardest would be the automobile related industries.

These days most consumers aren’t willing to spend without significant sales

incentives, such as the “Clash for Clunkers” program. Spending in all categories,

especially luxury goods is down and based on the table above, due to the

uncertainty in the future, most consumers are saving more.



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Consumer Spending: New Car Purchases during Recessions

As can be seen in the charts above, you will notice a trend in that during each of the

years hit by the recession, due to the decline in income per household and its effect

on spending, new car purchases has also seen a sharp drop, and what is most

interesting is that aside from an increase in the years 2000 and 2001, the new car

purchases numbers has continuously dropped to below the 1970’s numbers. This is

in direct contrast to the increase of the household median income, as can be seen in

the second chart, the reasons for this although interesting will not be touched upon in

this paper.



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Consumer Spending: Spurring Consumers to Spend

The American Government, in an effort to save the American Auto industry has

introduced a program to spur new car purchases, this program called the Car

Allowance Rebate System (CARS), colloquially known as "Cash for Clunkers", was a

US$3 billion U.S. federal scrappage program intended to provide economic

incentives to U.S. residents to purchase a new, more fuel efficient vehicle when

trading in a less fuel efficient vehicle. The program was promoted as providing

stimulus to the economy by boosting auto sales, while putting safer, cleaner and

more fuel-efficient vehicles on the roadways.

Some economists have argued that the “Cash for Clunkers” program is the kind of economic policy required to avoid the liquidity trap in times of economic depression,

they state that:

“The boost in demand that the rebates have brought about is exactly the sort of

stimulus that is urgently needed to escape what John Maynard Keynes called a

“liquidity trap”. According to his theory, consumers may become so worried about

the economy that they cling to as much liquid wealth as possible, cutting their

spending sharply and thereby triggering precisely the slump they feared. Moreover,

as stimulus policies go, cash-for-clunkers looks to be unusually effective. Admittedly,

that is not an especially demanding measure, given that Keynes (John Maynard

Keynes) favoured, if need be, burying money in bottles for people to dig up and

spend. Cash-for-clunkers has many benefits beyond simply getting more money

passing through the hands of consumers and into aggregate demand.” (The

Economist, 2009)

Take for instance, if a Honda City cost USD20,000, if you provide a rebate for

USD4,000. The price of the car would drop considerably to USD16,000. This is a

huge incentive for individuals thinking of buying a new car during the recession. A

graphical representation can be seen in the next page.

http://en.wikipedia.org/wiki/Liquidity_trap

http://en.wikipedia.org/wiki/Economic_depression

http://en.wikipedia.org/wiki/Economic_depression

http://en.wikipedia.org/wiki/Liquidity_trap



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Conclusion

In conclusion, it has clearly been shown that due to the recession experienced by

America, the Median Household Income for American families has also dropped.

This trend is seen through the years that during times of financial difficulties, the

income earned by an individual will decline, this in turn will change the consumer’s

spending habit from a “spend all” mentality to a “Save all” way of thinking. With more

and more consumers, saving more and spending less, a ‘liquidity trap’ may appear

and further increase the economic recession. As an example, new car purchaseshave declined remarkably, further endangering the American Automobile

manufacturers already suffering from the recession.

Due to that cause, the American government has spent USD 3 Billion to stimulate

the economy by offering new car purchases’ rebates on car prices. What impact this

may give to the recession will not be known until next year, 2010, when the exact

data on its given benefit to the American economy will be known.



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Bibliography

1. Barr, N. (2004). Problems and definition of measurement. In Economics of thewelfare state. New York: Oxford University Press. pp. 121-124

2. Case, K. & Fair, R. (2007). Principles of Economics. Upper Saddle River, NJ:Pearson Education. p. 54

Emerling, Suzi (2009). Less Spending on Gas and Cars Means More Money in theBank—For Now. Center for American Progress. Retrieved 3rd of November 2009, http://www.americanprogress.com

How the Recession Has Changed Consumer Behaviour, retrieved 4 th of November 2009, http://www.techcublog.com

Retail New Passenger Car Sales, retrieved 4th of November 2009,http://www.rita.dot.gov

Car Allowance Rebate System, retrieved 4th of November 2009,http://ww.wikipedia.org

Income, retrieved 4th of November 2009, http://www.wikipedia.org

Income, Poverty, and Health Insurance Coverage in the United States: 2008,Carmen DeNavas-Walt, Bernadette D. Proctor, Jessica C. Smith, retrieved 1st

November 2009, American Census Bureau

http://www.americanprogress.com/

http://www.techcublog.com/

http://www.rita.dot.gov/

http://ww.wikipedia.org/

http://www.wikipedia.org/

http://www.americanprogress.com/

http://www.techcublog.com/

http://www.rita.dot.gov/

http://ww.wikipedia.org/

http://www.wikipedia.org/

Assignment Economics MicroEcons for LKW MBA

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