group 4_microeconomics project report

IMT Ghaziabad

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Report on demand elasticity of automobiles in the Indian market

TABLE OF CONTENTS

1.0 INTRODUCTION……………………………………………………………...2

2.0 LITERATURE REVIEW.……………………………………………………..3

2.1 Demand Elasticity …………………................................................….....3

2.2 Income Elasticity …………………...........…...........…................……......3

2.3 Cross Elasticity ……………………......…...........…...........…...........…....3

3.0 AUTOMOBILE SEGMENT: TYPE OF MARKET………....……………….4

3.1 Few Large Players ……………………....…...........…...........…...............4

3.2 High Barrier for Entry and Exit ……………………..…...........…..............4

3.3 Interdependence ……………………..…...........…...........…...........…......4

3.4 Non Price Competition ………………………...........…...........…..............4

3.5 Group Behaviour …………………...........…...........…...........…....……....4

4.0 AUTOMOBILE SEGMENT: DEMAND CHARACTERISTICS……...……..5

5.0 AUTOMOBILE SEGMENT: DEMAND ELASTICITY………….............…..8

5.1 Price elaticity of demand ……………………...........…...........….......…....8

5.2 Income elasticity of demand ……………………...........…...........…….....9

5.3 Cross elasticity of demand …………………….…...........…....................12

6.0 CONCLUSION………...........…...........…...........…...........…...........……..12

APPENDIX………………...........…...........…...........…...........…...........………13

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1.Introduction

The automobile industry is one of India’s most vibrant and growing industries. This industry accounts for 22 per cent of the country's manufacturing gross domestic product (GDP). The auto sector is one of the biggest job creators, both directly and indirectly. It is estimated that every job created in an auto company leads to three to five indirect ancillary jobs.India's domestic market and its growth potential have been a big attraction for many global automakers. India is presently the world's third largest exporter of two-wheelers after China and Japan. According to a report by Standard Chartered Bank, India is likely to overtake Thailand in global auto-export market share by the year 2020.The next few years are projected to show solid but cautious growth due to improved affordability, rising incomes and untapped markets. With the government’s backing, and trends in the international scenario such as the decline in prices of natural rubber, the Indian automobile industry is slated to witness some major growth.

Market share of Indian automobile

Passenger vehicle production in India industry by volume

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2.Literature Review

2.1Demand Elasticity : In economics, the demand elasticity refers to how sensitive the demand for a good is to changes in other economic variables. Demand elasticity is important because it helps firms model the potential change in demand due to changes in price of the good, the effect of changes in prices of other goods and many other important market factors. A firm grasp of demand elasticity helps to guide firms toward more optimal competitive behavior. Elasticities greater than one are called "elastic," elasticities less than one are "inelastic," and elasticities equal to one are "unit elastic."

Demand Elasticity = % Change in Quantity Demanded / % Change in Price

2.2Income Elasticity : A measure of the relationship between a change in the quantity demanded for a particular good and a change in real income. Income elasticity of demand is an economics term that refers to the sensitivity of the quantity demanded for a certain product in response to a change in consumer incomes. The formula for calculating income elasticity of demand is:

Income Elasticity of Demand = % change in quantity demanded / % change in income

2.3Cross Elasticity : An economic concept that measures the responsiveness in the quantity demand of one good when a change in price takes place in another good. The measure is calculated by taking the percentage change in the quantity demanded of one good, divided by the percentage change in price of the substitute good:Cross Elasticity,

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3.Automobile Sector : Type of Market

Indian Automobile sector is an oligopolistic market with several players with highly differentiated products. The barriers of Entery and Exit are high, therby restricting entry of new players owing to large cost of setup. At the same time the players exiting the market faces a huge loss, if it is not able to find a suitable buyer for its assets.

The Market is characterized by :

3.1Few Large Players : Until liberazitation, the Indian automobile sector was largely a monolply market with Maruti Suzuki accounting for over 80% car sales. However, post reform the Indian automobile sector has many local and national players competing with each other in passenger car segement viz. Tata motors, Mahindra & mahindra, Toyota, Renault, Nissan, Ford, General Motors etc and luxary car segment viz. BMW, Porsche, Jaguar, Mercedes etc.

3.2High Barrier for Entry and Exit : Only a few new players could foray into this sector owing to huge cost related to setup of plant and Machinery. Research and development is also a huge cost as each competitor has to innovate new designs to gain an edge over their competitor. Firms under oligopoly are interdependent.

3.3 Interdependence: Interdependence means that actions of one firm affect the actions of other firms. A firm considers the action and reaction of the rival firms while determining its price and output levels. A change in output or price by one firm evokes reaction from other firms operating in the market.

3.4Non Price Competition : firms are in a position to influence the prices. However, they try to avoid price competition for the fear of price war. They follow the policy of price rigidity.

3.5Group Behaviour : The firms competing in the Automobile segment behave as a group. One company follows the path which the market leader is following. This prevents competiotion and Customers are left with no choice but to choose among the few options in the particular car segment.

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4.Automobile Sector : Demand Charactericstics

The demand for automobiles in India is largely cyclical in nature and dependent upon economic growth and per capita income. Seasonality is also a vital factor.

Automobile Domestic Sales Trends (Numberof Vehicles)

Category 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14Passenger Vehicles

15,52,703 19,51,333 25,01,542 26,29,839 26,65,015 25,03,685

Commercial Vehicles

3,84,194 5,32,721 6,84,905 8,09,499 7,93,211 6,32,738

Three Wheelers 3,49,727 4,40,392 5,26,024 5,13,281 5,38,290 4,79,634Two Wheelers 74,37,619 93,70,951 1,17,68,910 1,34,09,150 1,37,97,185 1,48,05,481Grand Total 97,24,243 1,22,95,397 1,54,81,381 1,73,61,769 1,77,93,701 1,84,21,538

Domestic Sales Trend (Source : SIAM, Society of Indian Automobile Manufacturers)

The demand curve for Automobile sector is “Kinked”. The kinked‐demand theory of oligopoly illustrates the high degree ofinterdependence that exists among the firms that make up an oligopoly. The market demand curve that each oligopolist faces is determined by the output and price decisions of the other firms in the oligopoly.

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The oligopolist's market demand curve becomes more elastic at prices above P because at these higher prices consumers are more likely to switch to the lower‐priced products provided by the other oligopolists in the market. Consequently, the demand for the oligopolist's output falls off more quickly at prices above P; in other words, the demand for the oligopolist's output becomes more elastic.

If the oligopolist reduces its price below P, it is assumed that its competitors will follow suit and reduce their prices as well. The oligopolist's market demand curve becomes less elastic at prices below P because the other oligopolists in the market have also reduced their prices. When oligopolists follow each others pricing decisions, consumer demand for each oligopolist's product will become less elastic (or less sensitive) to changes in price because each oligopolist is matching the price changes of its competitors.

For Example, lets take a look at the offering by 3 major players in the premium Hatchback car segment.

Volkswagen Polo Hyundai i20 [2012-2014]Maruti Suzuki Swift [2010-2011]

Comfortline 1.2L (P) Sportz 1.2 VDi ABS BS-IV

Price: 5.57 lakhs₹

Ex-showroom, New Delhi





On-Road Price On-Road Price On-Road Price

Above mentioned models are comparable yet differentiated in terms of luxary features. This segment is targeted to the soaring middle class of country. It

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http://www.carwale.com/volkswagen-cars/polo/

http://www.carwale.com/hyundai-cars/i20-2012-2014/

http://www.carwale.com/marutisuzuki-cars/swift-2010-2011/


can be noticed that despite being a differentiated product the prices of all the three cars are almost same.

None of the manufacturer can afford to increase the price of its model because Customer will move to the next available make and model which is offering the same value and benefits at lower cost. As a result the segment sees price rigidity with none of the manufacturers risking a reduced sales or a price war by incresing or decreasing the price of its model.

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5.Automobile Sector : Demand Elasticity

5.1Price elaticity of demand: As mentioned above the Automotive segment is an Oligopolistic market with a kinked demand curve and hence the demand is very price elastic in short term but inelastic in long term as all the players adjust their prices a price P which is competitive with other firms in the market. Being an oligoolistic market there is price rigidity and firms refrain from making drastic changes to the price of the cars (in a particular segment).This is the reason why, all major firm like Maruti Suzuki, Tata motors, Hyundai, Ford offer cars is a particlar segment like Hatch back, Sedan etc at a price which is comparable to their competitors. The demand of cars in India over the last 5 years is consistent despite the increasing Price. This could be contributed to the fact the demand for Automobiles is largely goverened by need rather than price. Adding to that, every firm has a no. of cars in its offer suiting an individuals pocket.

Car Sales in India (2010-2014)

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5.2Income elasticity of demand: The demand in Automobile industry industry is largely driven by the economic conditions and the per capita income.

In year Sales growth in 2011 slowed to just 4.3%, compared with a stellar 31% in the previous 12 months, according to data issued by the Society of Indian Automobile Manufacturers, or SIAM. Potential customers kept their cash firmly in the wallet as a series of fuel price increases, surging loan rates--the Reserve Bank of India has increased rates 13 times since March 2010--and the rising cost of living forced them to put off car purchases.

In the year 2012 -13 dragged down by slow economic growth and a demand slump, passenger car sales in the country fell by 6.7 per cent in the year ended March 2013, the first such decline in a decade. Factors such as high vehicle finance rates, in the range of 10.5 to 15 per cent, high inflation and high fuel prices, especially petrol, impacted car sales.

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Mean Car Sales (2010-14)

GDP of India (2010-14)

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Feb 14

Mar 14

April '14

May ' 1

4

June'14

July ' 1

4

Aug '14

Sept '

14

Oct ' 1

4

Nov ' 14

Dec '14

0

5000

10000

15000

20000

25000

SwiftPoloi20

(Car Sales for 2014 – Maruti Swift, Fiat Polo, Hyundai i20)

While the last month of every year generally witnesses dealerships handing out discounts, benefits and special schemes, trying to push out the crop of current model year cars, December 2014 was markedly different. While the buyer benefits were still on offer, incentives didn't seem to be the decisive factor in drawing customers to the showrooms. With news of the government discontinuing excise duty sops filtering in and some carmakers even announcing expected price hikes in the range of 4-6 percent from January, dealerships saw a rush of buyers.

It is evident that Customers are more driven by Economic policies, Interest rates, Income and other economic factors as compared to the price of Car.

5.3Cross elasticity of demand : The demand in Automobile is highly affected by the fuel price (Petrol/Diesel).

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Cheaper fuel brings down running costs. Lower running costs imply low cost of ownership. Lower cost of ownership drives sales. Cars become more affordable to run. Also, cheaper fuel implies other commodities are cheaper and disposable income increases.The changing economics of oil — narrowing price gap between diesel and petrol — has resulted in a shift again towards petrol cars. The industry had moved from what was originally just a petrol industry to being a diesel-dominated one from around November 2012 and now, with the deregulation of diesel pricing, it seems to be moving back towards a more balanced mix of petrol and diesel cars.

6.Conclusion:

The demand for Automobiles in India is :

Inelastic or Less Elastic to Price Elastic to Income Elastic to change in price of fuel.

Appendix:

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http://www.thehindu.com/sunday-anchor/low-fuel-prices-may-help-auto-sector-drive-up-sales/article6668317.ece

http://www.infomine.com/investment/metal-prices/crude-oil/5-year/

http://www.team-bhp.com/forum/indian-car-scene/156360-september-2014-indian-car-sales-figures-analysis.html

http://www.ibef.org/industry/india-automobiles.aspx

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http://www.infomine.com/investment/metal-prices/crude-oil/5-year/



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