South-Western College Publishing - Economics  
Kinder, Gentler, Used Car Selling Found Unprofitable
Subject Shut-down condition and supply curve
Topic Production and Cost
Key Words Seller, prices, salaried, commission, fixed costs, rebates, sales, staffing, profitability, pay, advertising.
News Story

AutoNation Inc. is the largest seller of new and used cars in the U.S. In its 37 used car superstores, there are typically over a thousand cars. Prices are marked and are not negotiable. Salespersons are salaried, not paid by commission.

This approach has led to problems. Fixed costs are high. The fixed prices have allowed competitors to undercut AutoNation. In addition, rebates on new cars have made late-model used cars less attractive.

As a result, AutoNation is closing most of its used car superstores and turning the rest into the used car portions of its new car dealerships. Overall company sales will fall only 5 percent because its core business is its 409 new car dealerships. Reductions in the staffing of corporate offices should help their profitability. Pay and advertising will be cut at poorly performing dealerships.

(Updated February 1, 1999)

1. Draw the marginal, average total, and average fixed cost curves for a used car superstore owned by AutoNation. Bear in mind the high fixed costs of such stores.
  a) Explain how your diagram reflects high fixed costs.
  b) Add a horizontal line representing the price at which the superstores' used cars were sold when the stores were profitable. Mark the quantity of cars supplied.
  c) As the price fell due to competition, what happened to the quantity supplied?
  d) Mark a price at which average variable costs were covered, but not average total costs. Was this a profitable position? Explain. Should AutoNation have shut down the superstore? Why or why not? Mark the quantity of cars supplied.
  e) Now mark a price below average variable cost. Was this a profitable position? Why or why not? Should AutoNation have shut the superstore down? Explain. Mark the quantity of cars supplied.
  f) Which price level must have existed recently, given the content of the news story?
  g) On your diagram, show the superstore's supply curve.
2. The new car dealerships will face lower fixed costs as the corporate office is reduced.
  a) Would the marginal, average total, or average variable cost curves be affected? Explain your answer.
  b) How would this affect the likelihood of the new car dealerships shutting down? Explain with reference to a diagram of the cost curves of a new car dealership.
Source Keith Bradsher, "AutoNation To Close Stores And Cut Jobs," The New York Times, December 14, 1999.

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