Real Automobile Demand Is Inelastic

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After traveling around the world, we have realized the automobile theme is fairly uniform in all Western and developing countries. No matter where you go, an automobile is extremely valuable from a purchasing power parity perspective, but it is priced very differently depending on the country.

Consumption of cars in North America remains very high. With the cheapest car prices in the world coupled with comparatively reasonable gas prices, this trend is not surprising. Similarly, in Europe and Israel, demand for cars continues to increase despite the strict tax policies on the automobile industry. It is extraordinary how much taxes can increase the cost of an automobile without reducing the demand for cars. The main result of high taxation seems to be smaller cars.

In many places, people have no choice but to drive and will pay almost anything for the privilege of doing so. Eight dollars a gallon for gas? Not a problem. Thirty thousand dollars for a new Ford Focus or Hyundai Elantra? Not a problem. Thirty or forty percent of take-home salary going toward supporting the car? Not a problem. The median household income in Israel is approximately $30,000 (http://www1.cbs.gov.il/shnaton57/st28_08.pdf), so if 30% to 40% of salary goes towards car payments each year, that’s approximately $36,000 over four years.

What we’re getting at here is this: even when we see a significant shift in commodity prices, once demand is established—whether it is in Israel, China, or the U.S.—it does not decrease. It is almost impossible to put someone down the consumption curve or wean people from cars and luxury items. The only thing taxation can do to the automobile industry is possibly reduce the average size of cars, which results in more space for more cars to be sold.

When people talk about the future reduction in demand from the Third World, they’re really talking about the reduction in net change in demand. A reduction in net change in demand, however, will not reduce commodity demand. What we could see happen is the growth rate in demand dropping from 10% to 2%, but we will not fundamentally see demand reduction.

Applying similar logic on the lack of demand elasticity to other items—refrigerators, AC units, iPhones—that require copper, iron ore, zinc, and other commodities shows how once consumers have an appliance, they generally won’t go back to living without it.

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