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Vi Lan Dao

Professor Davis
ECON 2010
12/01/2015

Article Review
I.

Introduction:

The name of the article I chose is Volkswagen Sales fall in October


amid Emission scandal written by William Boston and Sarah Sloat
on November 13, 2015 and published on wsj.com. On September
18, 2015, the United States Environmental Protection Agency (EPA)
issued a notice of violation of the Clean Air Act to Volkswagen
Group, after finding that the German automaker had been cheating
on emission tests in the U.S. by using a special software device.
Throughout the article, the authors discuss how the emission
scandal has affected the company, not only decreasing sales, but
also costing additional expenditures for insurance packages. In this
article review, I will be discussing Demand and Supply, Ceteris
paribus, Elasticity of demand and Stock price and how these
concepts relate to the case of Volkswagen.

II.

Article Summary:

Volkswagen recently reported a drop in new car sales in October as


the result of sharp decreases in the U.S. and Europe markets, due to
the companys recent emissions scandal.

Volkswagens headquarter, which is based in Germany, has been


negotiating with a group of banks to borrow up to 20 billion in
short-term financing to brace emissions-related costs. Until recently,
the company has already earmarked nearly $10 billion to cover the
costs related to its emissions scandal.

The company is expected to propose its solutions for repairing the


cars to regulators in the U.S. and in Europe soon. Volkswagen
representatives are expected to meet with officials from the U.S.
Environmental Protection Agency on November 20 to present the
companys solutions for nearly 500,000 cars in the U.S.

The companys VW, Skoda and SEAT brands were most affected by
the emissions crisis, and they all showed global declines for the
month. The steepest was for VW vehicles, Volkswagens biggest
business, which fell 5.3% to 490,000.
For the year through October, Volkswagens sales dropped 1.7% to
8.3 million.

In the U.S. market, deliveries for the Volkswagen group overall rose
only 5.7%, while VW brand sales were up only 0.2%. Though they
experienced a rise, the amount was very small compared to other
automakers in the U.S., where light-vehicle sales increased nearly
14% in October.

The company is offering $1,000 goodwill packages during this past


week to U.S. customers whose vehicles were affected by the

software as the first step in rebuilding trust and companys image


from customers.

Mr. Stackmann, Volkswagens sales executive announced recently


that The entire company is working to restore trust of our
customers, and Volkswagen would take care of each individual
customer who is affected.
III.

Analyze:

The microeconomic concepts I want to apply to my interpretation


are Demand and Supply, Ceteris paribus, Elasticity of demand, and
Stock price. Some of the ideas are more obvious, and some need to
be related to other factors. However, I believe that all of these
concepts are applicable in the case of Volkswagens emission
scandal.

First of all, I want to discuss Demand and Supply. In any market,


Demand is a schedule showing how much of a good or service
people will purchase at any price during a particular time period.
According to the law of demand, when the price of a good goes up,
people will buy less of it, and vice versa. On the other hand, Supply
is a schedule showing the relationship between price and quantity
supplied of a good or service for a specified period of time. As the
law of supply states, the higher the price of a good, the more of that
good will be produced by suppliers and vice versa.

Here is an example of the Demand curve (D) and Supply curve (S) of
the majority of firms in any industry in the economy. Lets assume
that this is the Demand curve and Supply curve for Volkswagen.
Theoretically, if the price of a car goes up, the quantity demanded
for that particular type of car would decrease and vice versa. The
point where (D) and (S) intersects is called Equilibrium (E), a
situation where quantity supplied equal quantity demanded at a
particular price. At the point of Equilibrium, the market works most
efficiently.

Any changes apart from price and quantity of a good will cause the
Demand curve to shift. We call these factors Ceteris paribus. By
definition, Ceteris Paribus conditions are those determinants of the
relationship between price and quantity that are unchanged along a
curve. Changes of these factors will cause the Demand curve to
shift. But we have to be aware of the fact that a change in Demand
is different from a change in Quantity demanded. A change in

Quantity demanded is a movement along the demand curve while a


change in Demand is a shift of the whole Demand curve to the left
or the right, depending on the situations.

A change/shift in Demand is caused by a change in any of the


Ceteris paribus conditions, while a change in Quantity demanded is
caused by a change in price of the good. Therefore, in order for (D)
to shift, a change in any of the ceteris paribus conditions has to
happen. Those conditions include: consumers income, consumer
tastes and preferences, the prices of related goods, expectations
regarding future prices and future incomes, and the market size. For
example, if consumers income decreases, consumers are expected
to spend less in the near future. As the result, the Demand Curve
will shift to the left.

This is an example of a shift in (D). Let assume that this is the graph
of Volkswagen Demand (D) and Supply (S). Because the company is
involving in a scandal related to its emissions test fraud, consumers

will lose trust in the company and will switch to other automaker
brands. In this case, the Ceteris paribus condition that we can apply
is consumers taste and preference. As Volkswagen has convicted
emissions test fraud, consumers preference changes as they switch
from buying from Volkswagen to other automobile brands such as
Ford, BMW, Toyota, etc. As consumers preference turns against
Volkswagen, the original Demand curve (red) will shift to the left,
representing a new Demand curve (purple). As the result, Quantity
demanded decreases from Q1 to Q2, and price is also be expected
to go down from P1 to P2. Since (D) shifts, Equilibrium (E) will also
move from the blue point to the purple point, illustrating a smaller
quantity produced as well as a smaller price.

The versatile economic conditions when (D) and (S) are likely to shift
is made even more possible since Volkswagen is operated in an
Oligopoly. Oligopoly is a market structure in which there are very
few big sellers. Each seller can somehow predict how the other
sellers will react to its changes in prices, quantities, and qualities. In
an oligopoly, firms are strategically interdependent. One firms
actions with respect to price, quality, advertising, etc. will be
strategically countered by the reactions of one or more other firms
in the industry. Therefore, automobile market is that of an oligopoly.

Automobile companies have to invest a lot in advertising in order to


differentiate their products from other brands products. In addition
to that, their marketing and sales strategies are also
interdependent. For example, if Toyota has good deals on

Thanksgiving, other automobile companies will also have to offer


good promotion for consumers in order to sell their products,
otherwise, consumers will buy cars from Toyota rather than from
other brands. Because of operating in a highly competitive market
like this, any negative change against Volkswagen will have a great
impact on the company, making consumers switch to another
brand. As the result, sales will drop and profits will also decrease.
We can clearly see this in the article, as the author wrote:
Deliveries of VW brand vehicles drop 5.3% and For the year
through October, Volkswagens sales dropped 1.7% to 8.3 million
(William Boston, Sarah Sloat).

In an Oligopoly, Demand is relatively elastic. Price elasticity of


demand (Ep) is used to measure the responsiveness of the quantity
demanded of a good when it price changes. Price elasticity of
demand is calculated using a particular formula. If the absolute
amount of (Ep) is greater than 1, we said the good has high price
elasticity of demand. As the result, any minor change in price can
lead to a great change in the quantity demanded of a good. Since
(Ep) of Automobile is normally greater than 1, we said that
Automobile is operated in a relatively elastic demand market. This
means that any change that makes the automobile price of a
particular brand goes up, consumers demand for that automobile
will goes down, as they switch to another type of car or another
brand with a more competitive price.

The Volkswagens emissions fraud doesnt push up the price of


Volkswagens automobiles. However, since the price stays constant,
but the emission software is considered fraudulent and not as good
compared to other brands, consumers would perceive that
Volkswagens defected automobiles cost more than they should, and
can lead to more long-term costs not only to the owners but also to
the environment. As the result, right after the scandal, sales of
Volkswagen dropped significantly.

Because Sales of Volkswagen dropped remarkably and the


companys reputation and public image also got damaged, the
companys Stock price also dropped.

This graph showed how Volkswagens stock price plummeted after


the company admitted cheating on the emissions test. Volkswagen
experienced a sudden drop at the end of September when it said
the defected software was implemented in 11 million vehicles. A
companys worth, or its total value is represented in the companys

stock price. And since Volkswagens sales fell significantly during


September and October, and its public image was also damaged,
consumers and investors perceived the company to worth less, and
its stock price went down as the result.

IV.

Application:

The case of Volkswagen gives me some economic and business


applications that I find useful to me personally. Since we will all have
to involve in some forms of business in the future and will be greatly
affected by the economic world, its important to consider our
business decisions carefully and be able to predict the effects these
decisions can have. Especially for those entrepreneurs who want to
own and run a business in the future, its essential to be able to
strike a balance between profits and conscience. Making frauds is
not only a bad way to make profits but also brings harms to the
society. Frauds are unethical, immoral, and unsustainable, and
therefore, need to be prevented and prohibited in the business and
economic world.

Source
1. Boston, William, and Sarah Sloat. "Volkswagen Sales Fall in
October Amid Emissions Scandal." WSJ. N.p., 13 Nov. 2015.
Web. 01 Dec. 2015.
2. Heakal, Reem. "Economics Basics: Supply and Demand |
Investopedia." Investopedia. N.p., 30 Nov. 2003. Web. 01 Dec.
2015.