Question

Automobile manufacturing is an industry subject to significant economies of scale. Suppose there are four domestic auto manufacturers, but the demand for domestic autos is no more than 2.5 times the quantity produced at the bottom of the long-run average cost curve. What do you expect will happen to the domestic auto industry in the long run?

Short answer

In the long run, we can expect the domestic auto industry to consolidate through mergers, acquisitions, or some firms exiting the market. The remaining firms will likely have a larger market share and a higher output level, allowing them to achieve a lower average cost due to economies of scale. Overall, the domestic auto industry may become more concentrated, with fewer, larger firms able to operate more efficiently and at a lower cost.

Step-by-step solution

Understand the concept of economies of scale

Economies of scale occur when a firm's average costs decrease as the firm increases its output. In industries with significant economies of scale, larger firms can produce at a lower average cost than smaller firms, leading to higher profits.

Analyze the given industry conditions

Given that there are four domestic auto manufacturers and the demand is no more than 2.5 times the quantity produced at the lowest long-run average cost, it means that if all firms produce at the minimum average cost, the total market demand will be able to support only 2.5 firms operating at their most efficient scale.

Predict the industry adjustments

In the long run, firms operating in an industry with significant economies of scale will try to achieve the lowest possible average cost in order to maximize their profits. Since the market demand can only support 2.5 firms operating at their most efficient scale, it is likely that some firms will expand their production while others will exit the market or scale down their production. This will result in a smaller number of larger firms in the industry, as they strive to reap the benefits of economies of scale.

Identify the possible long-run outcome

In the long run, we can expect the domestic auto industry to consolidate. This would happen through mergers, acquisitions, or some firms exiting the market. The remaining firms will likely have a larger market share, and a higher output level allowing them to achieve a lower average cost due to economies of scale. Overall, the domestic auto industry may become more concentrated, with fewer, larger firms able to operate more efficiently and at a lower cost.