Commentary coversheet

Economics commentary number : HL number 1

Title of extract : VW leads field but expects brake on

earning

Source of extract : financial times

Date of extract : 07.04.2009

Word count : 666 words

Date the commentary was written :

Candidate name : Mariusz Nguyen Long Thanh

Candidate number :
Commentary 1
Price elasticity of demand (PED ) is the measure of the responsiveness of
the demand for a certain good to a change in the price of this good. It is a
measure of how consumers react to a change in price.

The formula used to calculate the price elasticity of demand for a given product is :

% change in quantity demanded of good A

PED =
% change in prices of good A

Figure 1 : demand
“VW on Monday revealed net income of €4.7bn ($6bn) last year, 14 per
cent higher than in 2007, while sales increased 4.5 per cent to €114bn as
VW sold 6.3m vehicles.”
This situation is shown in figure 1. There was a shift in demand curve to
the right, from D1 to D2, as sales increased. VW sales increased from Q1
to Q2, and they could set higher price for their cars, which increased from
p1 to p2.
Car market is a type of a monopolistically competitive market.
Monopolistic competition has two basic assumptions. Firstly, the
producers haven't much impact on degree of control over price. It means
that they have to keep low prices for cars, because the marker is very
competitive. Secondly, there are many producers and many consumers,
while no business has total control over the market price.

Moreover, it is assumed that all firms are profit-maximizes, and the same
is with Volkswagen. It will not be concerned about revenue maximization
or sales maximization, but only profit maximization. The number of
workers it employs is also not important, nor environmental aims which
are crucial these days. Most of the firms are not concerned about the
environment, and this is why there is negative externality of consumption
and production of VW cars. Manufactures emit greenhouse gasses and
consumers’ cars also emit greenhouse gasses. However, Volkswagen
wants only to maximize its profit.

As car market is monopolistically competitive market, figure 2 will best

represents VW costs and revenues. “VW on Monday revealed net income
of €4.7bn ($6bn) last year”, so there was abnormal profit which is marked
as pink area on the figure 2. The abnormal profit is the total revenue
minus total cost at the level of output where MC curve is equal to MR
curve. Porsche said that talks with
Figure 2 : abnormal profit

Figure 3. losses
It is said in the article that this year “earnings will not reach the high levels
of previous years.”. It may be possible that VW will make only losses,
which is shown in figure 3. Again, the total abnormal profit or loss is
between the AC curve and AR curve at the level of output where profits
are maximized (Q). The loss of Volkswagen is marked as the red rectangle
in figure 3.

VW has many ways to increase demand for their cars. First of all, they
should spend more money on innovation, because consumers can be
attracted by VW cars with the newest technology. VW works in
monopolistic competition and it can “steal” consumers from other car
makers, who will prefer Volkswagen cars.

There are three possibilities of what VW may do. Volkswagen should shut
down in the short run if it is unable to cover all its variable costs in the
short run. This level of price is knows as shut-down price. Secondly, it may
operate in the short run, when it is able to cover all its variable costs in the
short run. This is known as break-even price and VW will operate in the
short run so that it can make an abnormal profit in the long run. Finally,
Volkswagen may operate at the profit-maximizing level of output if it
wants to make abnormal profit in the short run.