South-Western College Publishing - Economics  
Chrysler Crisis
Subject Market Equilibrium
Topic Product Markets
Key Words Demand, Overcapacity, Rebates, Prices, Profits, Merger
News Story Chrysler, like other U.S. car producers, is experiencing little growth in the demand for automobiles. At the same time, there is overcapacity among auto producers. As a result, Chrysler has offered incentives to spur sales, including subsidized lease rates, cheap financing, and rebates. The incentives average $1,525 a car.

Chrysler is introducing new models, such as a new Grand Cherokee sport-utility vehicle, and hopes that they will permit incentives to be reduced. While consumers will face higher prices, Chrysler will earn bigger profits. Looking to the next few years, the Chairman of Chrysler predicted that the overcapacity in the industry would continue but not worsen. He expects demand to fall when the economy slows down, but not by as much as in the past.

Another development is that Chrysler and Daimler-Benz are hoping to merge in the autumn. Details are to be announced later.
(Updated June 5, 1998)

Questions
  1. Draw a supply and demand diagram of the market for automobiles. Show the equilibrium price and quantity.
    1. The news story describes a situation in which Chrysler and other companies cannot sell their vehicles at sticker price. At what level must the sticker price be? Show the price on the diagram and label the surplus.
    2. Explain why Chrysler and other producers are offering various financial incentives. Refer what this does to the price of vehicles, the quantity demanded, the quantity supplied, and the surplus. Illustrate on your diagram.

  2. Draw another diagram showing the disequilibrium in Question 1(a). The introduction of new models is expected to help reduce the need for incentives. Explain why and illustrate on your diagram.

  3. Draw another diagram of the disequilibrium like the one in Question 1(a).
    1. If the merger with Daimler-Benz is permitted, what might happen to the supply curve? Why?
    2. What would happen to the equilibrium price and quantity and the magnitude of the disequilibrium? Illustrate on your diagram.
Source Gregory L. White, "Chrysler Hopes New Models Will Bring Reductions in Costly Sales Incentives," Wall Street Journal, May 22, 1998.

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