Macroeconomics - discussion question (1)

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Select a macroeconomic event and explain why you believe that this event does influence management decisions and why management cannot control it.

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PART 1 Microeconomic Analysis 1 Managers and Economics W hy should managers study economics? Many of you are probably asking yourself this question as you open this text. Students in Master of Business Administration (MBA) and Executive MBA programs usually have some knowledge of the topics that will be covered in their accounting, marketing, finance, and management courses. You may have already used many of those skills on the job or have decided that you want to concentrate in one of those areas in your program of study. But economics is different. Although you may have taken one or two introductory economics courses at some point in the past, most of you are not going to become economists. From these economics classes, you probably have vague memories of different graphs, algebraic equations, and terms such as elasticity of demand and marginal propensity to consume. However, you may have never really understood how economics is relevant to managerial decision making. As you’ll learn in this chapter, managers need to understand the insights of both microeconomics, which focuses on the behavior of individual consumers, firms, and industries, and macroeconomics, which analyzes issues in the overall economic environment. Although these subjects are typically taught separately, this text presents the ideas from both approaches and then integrates them from a managerial decision-making perspective. As in all chapters in this text, we begin our analysis with a case study. The case in this chapter, which focuses on the global automobile industry, provides an overview of the issues we’ll discuss throughout this text. In particular, the case illustrates how the automobile industry is influenced by both the microeconomic issues related to production, cost, and consumer demand and the larger macroeconomic issues including the uncertainty in global economic activity, particularly in Europe, and the value of various countries’ currencies relative to the U.S. dollar. 32 M01_FARN0095_03_GE_C01.INDD 32 11/08/14 5:17 PM Case for Analysis Micro- and Macroeconomic Influences on the Global Automobile Industry In September 2012, U.S. automobile sales increased to 1.19 million cars and light trucks per month, a 12.8 percent increase from a year earlier. This increase represented an annualized rate of 14.94 million vehicles, the highest sales rate since March 2008 before the recession began in the United States. Much of the increase was driven by passenger car sales at Toyota Motor Corp., Honda Motor Co., and Chrysler Group LLC. There was a significant increase in sales for Toyota and Honda from the previous year, as both companies were recovering from the earthquake that hit Japan in March 2011.1 Analysts noted similar increases in August 2012 that were attributed to pent-up consumer demand for replacing aging vehicles and the lowinterest financing and other incentives Japanese auto makers offered to regain market share lost in 2011 due to the lack of availability of their cars.2 Automobile production in the United States had expanded in 2012, given favorable foreign exchange rates and a plentiful supply of affordable labor. Toyota, Honda, and Nissan Motor Co. all increased their production capacity in the United States with the goal of shipping automobiles to Europe, Korea, the Middle East, and other countries. The strong value of the yen, and conversely the weak U.S. dollar, gave Japanese producers the incentive to produce cars in the United States for export around the world. This investment by foreign automobile producers helped the U.S. economy that was still struggling to recover from the recession of 2007–2009. Automobile industry employment in the United States was estimated to increase from 566,400 in 2010 to 756,800 in 2015. Although these estimates were well below the 1.1 million automobile workers employed in 1999, they indicated that the economic recovery was moving forward. General Motors Co., which had once encouraged auto parts 1 Jeff Bennett, “Corporate News: Passenger Cars Lift U.S. Sales— Big Gains for Toyota, Honda, Chrysler: Pickup Weakness Weighs on GM, Ford,” Wall Street Journal (Online), October 3, 2012. 2 Christina Rogers, “August U.S. Car Sales Surge,” Wall Street Journal (Online), September 4, 2012. suppliers to relocate in low-wage countries, now encouraged them to locate near U.S. auto plants.3 U.S. auto producers, who had once essentially lost the competition to their Japanese rivals in the 1980s and 1990s and who went through government-backed (GM and Chrysler) or private (Ford) restructurings during the U.S. recession, regained profitability and invested in the engineering and redesign of their cars. Several Fords were designed with a voiceoperated Sync entertainment system, and the Chevrolet Cruze that was launched in 2010 came with 10 air bags compared with 6 for the Toyota Corolla. As the U.S. economy recovered, Americans also began purchasing more trucks and sport-utility vehicles (SUVs), which helped to restore profits and market share for the Detroit auto makers. Trucks and SUVs made up 47.3 percent of the U.S. market in 2009, 50.2 percent in 2010, and 50.8 percent in 2011. This segment of the market had been hit particularly hard during the U.S. recession.4 As the U.S. automobile industry revived, the competition between Ford and GM again became more intense. In 2008, Ford supported the government bailout for GM and Chrysler because Ford was worried that a collapse of these companies would also impact the auto parts industry. As the domestic auto industry recovered, Ford, which had often focused just on Toyota as its key competitor, began developing strategies to counter GM. Ford realized that customers who had long been loyal to Asian brands were again looking at U.S. cars, given the generally perceived quality increases in the U.S. auto industry.5 3 Joseph B. White, Jeff Bennett, and Lauren Weber, “Car Makers’ U-Turn Steers Job Gains,” Wall Street Journal (Online), January 23, 2012; Neal Boudette, “New U.S. Car Plants Signal Renewal for Manufacturing,” Wall Street Journal (Online), January 26, 2012. 4 Mike Ramsey and Sharon Terlep, “Americans Embrace SUVs Again,” Wall Street Journal (Online), December 2, 2011; Jeff Bennett and Neal E. Boudette, “Revitalized Detroit Makes Bold Bets on New Models,” Wall Street Journal (Online), January 9, 2012. 5 Sharon Terlep and Mike Ramsey, “Ford and GM Renew a Bitter Rivalry,” Wall Street Journal (Online), November 23, 2011. 33 M01_FARN0095_03_GE_C01.INDD 33 11/08/14 5:17 PM 34 PART 1 Microeconomic Analysis Japanese auto makers in 2011 and 2012 faced managerial decisions that were influenced both by the nature of the competition from their rivals and by macroeconomic conditions, most importantly the value of the exchange rate between the yen and the U.S. dollar.6 Production by both Toyota and Honda was hit by the earthquake and tsunami in Japan in March 2011 and by subsequent flooding in Thailand that disrupted the supply of electronics and other auto parts made there. Toyota sales were also influenced by the recall and quality issues in 2010 related to the gas pedal and floor mat design. Honda’s redesigned 2012 Civic was criticized for its technology and lessthan-luxurious interior. The car was dropped from Consumer Reports’ recommended list in August 2011. Honda officials acknowledged that they had underestimated the competition from U.S. producers. The strong yen, which made exports from Japan less price competitive, also gave the Japanese producers the incentive to produce their cars in the United States. Honda, which had produced 1.29 million vehicles in North America in 2010, planned to open a new plant in Mexico and expand production in all seven of its existing assembly plants to 2 million cars and trucks per year. Production abroad was a particular issue for Toyota, which made half of its automobiles in Japan, compared to Honda and Nissan, which produced about one-third of their output in Japan. The president of Toyota, Akio Toyoda, grandson of the company founder, had made a public commitment to build at least 3 million cars in Japan annually, half of which would be for export. Some company officials argued for streamlining production in Japan by decreasing production without raising costs, essentially redefining the economies of scale in the company’s production process. These officials believed the company could meet domestic goals with high-precision production, cost-cutting, and collaboration on new technology with parts suppliers. Auto producers also focused on China during this period, although there was concern about the slowing Chinese economy.7 Auto sales in China increased only 2.5 percent in 2011 compared with increases of 46 percent in 2009 and 32 percent 6 The following discussion is based on Jeff Bennett and Neal E. Boudette, “Revitalized Detroit Makes Bold Bets on New Models”; Mike Ramsey and Yoshio Takahashi, “Car Wreck: Honda and Toyota,” Wall Street Journal (Online), November 1, 2011; Chester Dawson, “For Toyota, Patriotism and Profits May Not Mix,” Wall Street Journal (Online), November 29, 2011; Mike Ramsey and Neal E. Boudette, “Honda Revs Up Outside Japan,” Wall Street Journal (Online), December 21, 2011; and Yoshio Takahashi and Chester Dawson, “Japan Auto Makers on a Roll,” Wall Street Journal (Online), April 22, 2012. 7 This discussion is based on Andrew Galbraith, “Car Makers Still Look to China,” Wall Street Journal (Online), April 19, 2012; Sharon Terlep and Mike Ramsey, “Ford Bets $5 Billion on Made in China,” Wall Street Journal (Online), April 20, 2012; Chester Dawson and Sharon Terlep, “China Ramps Up Auto Exports,” Wall Street Journal (Online), April 24, 2012; and Sharon Terlep, “Balancing the Give and Take in GM’s Chinese Partnership,” Wall Street Journal (Online), August 19, 2012. M01_FARN0095_03_GE_C01.INDD 34 in 2010. However, the size of the Chinese economy continued to be the major incentive for expansion in that country. In April 2012, Ford announced that it would build its fifth factory in eastern China as part of its plan to double its production capacity and sales outlets in the country by 2015. This production increase would make the company capable of producing 1.2 million passenger cars in China, approximately half of the number of cars it built in North America in 2011. Ford lagged behind other major auto producers in entering the world’s largest car market. Ford’s strategy was to build cars from platforms developed elsewhere to minimize costs. However, these platforms might not provide enough space in the back seats to appeal to affluent Chinese, who often employed drivers. General Motors developed a partnership with Chinese SAIC Motor Corp. to become the dominant foreign competitor in China. This partnership resulted in production changes such as designing Cadillacs with softer corners, dashboards with more gadgets, and increasing the comfort of the rear seats to appeal to Chinese consumers. The challenge for GM was that SAIC could also use GM’s expertise and technology to make itself a major competitor with the U.S. company. In 2012, the Chinese automobile industry began increasing exports, although these were not thought to be a threat in developed markets in the United States and Europe, given perceived quality issues including lack of air-conditioning and power windows. However, Chinese producers were making inroads into emerging markets in Africa, Asia, and Latin America. The other major influence on the global auto industry in 2011 and 2012 was the recession and economic crisis in Europe.8 In October 2012, Ford announced a plan to cut its operating losses in Europe by closing three auto-assembly and parts factories in the region, reduce its workforce by 13 percent, and decrease automobile production by 18 percent. Ford predicted a loss of $1.5 billion in Europe in 2012 and a similar loss in 2013. The cost-cutting in Europe was combined with the introduction of several new commercial vans and SUVs and the introduction of the Mustang sports car for the first time. All European auto makers faced decreased car sales and chronic overcapacity at this time. Daimler AG, maker of MercedesBenz automobiles, announced that it would not achieve its profit targets, while PSA Peugeot Citroen SA announced a government bailout of its financing arm and a cost-sharing pact with General Motors. There had been a smaller decrease in auto-producing capacity in Europe since the 2008 financial crisis compared with that during the restructuring of the U.S. auto industry that was influenced by the federal government bailout. 8 This discussion is based on Sharon Terlep and Sam Schechner, “GM, Peugeot Take Aim at Europe Woes,” Wall Street Journal (Online), July 12, 2012; Mike Ramsey, David Pearson, and Matthew Curtin, “Daimler Warns as Europe Car Makers Cut Back,” Wall Street Journal (Online), October 24, 2012; and Marietta Cauchi and Mike Ramsey, “Ford to Shut 3 Europe Plants,” Wall Street Journal (Online), October 25, 2012. 11/08/14 5:17 PM CHAPTER 1 Managers and Economics 35 Two Perspectives: Microeconomics and Macroeconomics As noted above, microeconomics is the branch of economics that analyzes the decisions that individual consumers and producers make as they operate in a market economy. When microeconomics is applied to business decision making, it is called managerial economics. The key element in any market system is pricing, because this type of system is based on the buying and selling of goods and services. As we’ll discuss later in the chapter, prices—the amounts of money that are charged for different goods and services in a market economy—act as signals that influence the behavior of both consumers and producers of these goods and services. Managers must understand how prices are determined—for both the outputs, or products sold by a firm, and the inputs, or resources (such as land, labor, capital, raw materials, and entrepreneurship) that the firm must purchase in order to produce its output. Output prices influence the revenue a firm derives from the sale of its products, while input prices influence a firm’s costs of production. As you’ll learn throughout this text, many managerial actions and decisions are based on expected responses to changes in these prices and on the ability of a manager to influence these prices. Managerial decisions are also influenced by events that occur in the larger economic environment in which businesses operate. Changes in the overall level of economic activity, interest rates, unemployment rates, and exchange rates both at home and abroad create new opportunities and challenges for a firm’s competitive strategy. This is the subject matter of macroeconomics, which we’ll cover in the second half of this text. Managers need to be familiar with the underlying macroeconomic models that economic forecasters use to predict changes in the macroeconomy and with how different firms and industries respond to these changes. Most of these changes affect individual firms via the pricing mechanism, so there is a strong connection between microeconomic and macroeconomic analysis.9 In essence, macroeconomic analysis can be thought of as viewing the economy from an airplane 30,000 feet in the air, whereas with microeconomics the observer is on the ground walking among the firms and consumers. While on the ground, an observer can see the interaction between individual firms and consumers and the competitive strategies that various firms develop. At 30,000 feet, however, an observer doesn’t see the same level of detail. In macroeconomics, we analyze the behavior of individuals aggregated into different sectors in the economy to determine the impact of changes in this behavior on the overall level of economic activity. In turn, this overall level of activity combines with changes in various macro variables, such as interest rates and exchange rates, to affect the competitive strategies of individual firms and industries, the subject matter of microeconomics. Let’s now look at these microeconomic influences on managers in more detail. Microeconomics The branch of economics that analyzes the decisions that individual consumers, firms, and industries make as they produce, buy, and sell goods and services. Managerial economics Microeconomics applied to business decision making. Prices The amounts of money that are charged for goods and services in a market economy. Prices act as signals that influence the behavior of both consumers and producers of these goods and services. Outputs The final goods and services produced and sold by firms in a market economy. Inputs The factors of production, such as land, labor, capital, raw materials, and entrepreneurship, that are used to produce the outputs, or final goods and services, that are bought and sold in a market economy. Macroeconomics The branch of economics that focuses on the overall level of economic activity, changes in the price level, and the amount of unemployment by analyzing group or aggregate behavior in different sectors of the economy. 9 Note that the terms micro and macro are used differently in various business disciplines. For example, in Marketing Management, The Millennium Edition (Prentice Hall, 2000), Philip Kotler describes the “macro environment” as dealing with all forces external to the firm. His examples include both (1) the gradual opening of new markets in many countries and the growth in global brands of various products (microeconomic factors for the economist) and (2) the debt problems of many countries and the fragility of the international financial system (macroeconomic problems from the economic perspective). In each business discipline, you need to learn how these terms and concepts are defined. M01_FARN0095_03_GE_C01.INDD 35 11/08/14 5:17 PM 36 PART 1 Microeconomic Analysis Microeconomic Influences on Managers Relative prices The price of one good in relation to the price of another, similar good, which is the way prices are defined in microeconomics. The discussion of the global automobile industry in the opening case illustrates several microeconomic factors influencing managerial decisions. In 2012, Japanese auto makers used low-interest financing and other incentives to regain market share lost in previous years. Toyota had to recover from the impact of its recall and negative quality issues in 2010, while Honda stumbled on the redesign of its 2012 Civic by not incorporating features offered by its competitors. U.S. auto makers reengineered and redesigned their production processes to add features with greater customer appeal. They also responded to the increased demand for trucks and SUVs, a market segment that had been negatively impacted by the recession. Ford and GM began reengaging in their traditional market rivalry. All producers who planned to sell in China, the world’s largest automobile market, had to recognize the difference in tastes and preferences of Chinese consumers, such as the desire for larger back seats. Decisions about demand, supply, production, and market structure are all microeconomic choices that managers must make. Some decisions focus on the factors that affect consumer behavior and the willingness of consumers to buy one firm’s product as opposed to that of a competitor. Thus, managers need to understand the variables influencing consumer demand for their products. Because consumers typically have a choice among competing products, these choices and the demand for each product are influenced by relative prices, the price of one good in relation to that of another, similar good. Relative prices are the focus of microeconomic analysis. The Japanese auto makers’ use of low-interest financing and other pri ...
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School: Duke University

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Macroeconomics - Discussion Question (1)

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Macroeconomics - Discussion Question (1)
One of the most prominent macroeconomic events is changing consumption and
investment behavior of consumers and firms in an economy’s private sector, which influence a
country’s GDP. There are numerous factors w...

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