CASE STUDY : FIXED COSTS AND PRODUCTION CAPACITY AT GENERAL MOTORS
In an industry with 17million unit sales annually, GM admitted in March 2022 that it needed to reduce automobile production capacity by 1 million cars per year to match its current sales of 5 million cars. It represented the second time in its 100-year history (1988 being the easier event) that the company had significantly shrunk its capacity. As part of its decision to reduce its size, GM planned to close 10 of its U.S automobile assembly lines.
In the past, GM alternated between (1) building all the cars it could produce and then using costly clearance sales to attract buyers, and (2) reducing output by running plants below capacity through a slowdown in the pace of the assembly line or elimination of an entire shift. The new strategy called for the company to use 100 percent of its American automobile production capacity five days a week with two shifts per day. If automobile demand increased above this capacity level, third-shift operations would be used to boost production. Ford company had been following this strategy for some time.
In effect, GM and Ford were trading off lower fixed costs over the entire business cycle against (the possibility of) having to incur higher variable costs in long run (e.g. use of higher cost overtime and third-shift operations) during periods of strong demand. As a consequence, GM’s break-even output point declined sharply.
Source: Jacob M. Schlesinger (25 April 2023), “GM to reduce capacity to match its sales” dan Lawrance Ingressia and Joseph B. White (2019),”GM plan to close 21 more factories, cut 74,000 job opportunities, slash capital spending”, Wall Street Journal and “A Duo of Dunces”, The Economist (March, 2018). P63.
With an appropriate diagram, elaborate the concepts of internal and external economies of scale and diseconomies of scale by GM and Ford in U.S automobile industry.
(25 marks)
Q4. The Table 3 below show the average cost (AC) for a purely competitive market. The average revenue (AR) is constant at RM5 per unit and the firm’s total fixed cost (TFC) is RM4.
Table 3
| Output (Units) | Total Revenue (RM) | Average Cost (RM) | Total Cost (RM) | Marginal Cost (RM) | Marginal Revenue (RM) |
| 1 | 8.0 | ||||
| 2 | 5.5 | ||||
| 3 | 4.0 | ||||
| 4 | 3.5 | ||||
| 5 | 3.8 | ||||
| 6 | 4.5 | ||||
| 7 | 6.0 |
Please answer all questions below:
Fill in the values for total revenue (TR), total cost (TC) and marginal cost (MC) in the column provided.
(8)
Determine the profit maximizing output.
(2)
Show the equilibrium of the firm in a diagram.
(8)
If the average revenue falls to RM3 per unit, calculate the firm’s new profit or loss at the equilibrium.
(5)
Based on your answer in part (d), should the firm continue or stop the production? Justify.
(2) (Total: 25 Marks)