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Asked by achu | Oct 5, 2007 | University Level > Economics > Homework
achu
achu asks:

1) DETROIT -- Here's a million-dollar question: How does the global economy connect American car buyers and Russian bureaucrats?
One person who can answer is Reg Modlin, an emissions specialist at DaimlerChrysler AG's U.S. unit. Mr. Modlin, like many other auto-industry executives worldwide, has spent the past several weeks fretting about the soaring price of an obscure, grayish metal called palladium. Many people haven't even heard of it, but for anyone who wants to make a cleaner car or sport-utility vehicle, the precious metal is a must-have. Too bad the main source of the stuff is Russia.
The Price of an Ounce
Last month, concerns that political infighting in Moscow might choke future supplies drove the price of palladium to nearly $1,000 an ounce. Although there is less than an ounce of palladium in most vehicles -- it is used inside the catalytic converter -- that kind of price surge means palladium suddenly is becoming a big-ticket item for auto companies. Car makers brought much of this on themselves. In the mid-1990s, they agreed to accelerate their adoption of tighter national emission standards as part of a deal to head off separate state-by-state rules, which would have played havoc with manufacturing and distribution. Palladium looked like the best solution, since it began cleaning exhaust sooner after starting up than platinum, then the dominant metal in catalytic converters. Plus, the price for little-used palladium hadn't gone above $200 a ounce in more than a decade, while platinum had jumped above $400. Following this decision, palladium prices jumped in the late 90's , but remained below $400 an ounce until this year.…However many automakers are projected to have a big increase in palladium consumption in 2000, as they began to roll out models to meet the tighter national emission rules as regulators turn their focus to explosively popular trucks and SUVs, which have been subject to more-lenient rules. Palladium turns out to be particularly good at cleaning their exhaust. Although there is now a huge effort under way at many companies to find ways to use less palladium, changing car designs in that way will take several years.

a)Based on information in the above article is the demand for palladium elastic or inelastic? Explain your answer. i.e. What about palladium and its use in automobile manufacturing creates its high or its low elasticity of demand ?

etutor answers:

It would appear from the text that the demand for palladium is price inelastic - in other words, an increase in its price brings about a less than proportionate fall in the quantity demanded.

The text refers to its use in 'cleaner cars', where it is described as a 'must-have'. Given the increase in production of cars with 'tighter emission standards' demand by motor manufacturers has increased sharply in recent years, despite increases in its price.

In normal circumstances, firms would be looking for a cheaper alternative - either a different supplier of palladium or else another precious metal that fulfils much the same cleansing function. But it is clear from the text that there are few, if any short-term substitutes for palladium, which confirms the inelastic demand for the metal, since a lack of substitutes is a characteristic of commodities in inelastic demand.

Developing the above point, first, the text states that 'the main source of the stuff is Russia'. Hence we can infer that the rest of the world supplies only a small proportion of the overall market. This suggests that Russian suppliers face little competition - if they did, they would not have been able to push up the price to 'nearly $1000 an ounce' - proof of inelastic demand.

Second, the only feasible alternative, platinum, is now considerably cheaper than palladium. But this is of no benefit to automobile producers since it would involve 'changing car designs' which, according to the text, 'will take several years'. It is possible that in the long run, it might become economical for manufacturers to alter designs and to revert to the cheaper platinum. If this were the case, then eventually (after many years) the demand for palladium might become more price elastic (assuming no large increase in the price of platinum in the intervening period).

I hope this is helpful.

1 student responses

achu
achu

Hi,

   So if I were to draw a supply - demand diagram of the market for palladium which illustrates the price jump from $400 to $1000 per ounce that occurred between the 1999 model year and the start of the 2000 model year.  Is it going to go upward? 

Thanks.

responded Oct 7, 2007 5:51:13 PM BST
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