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					Oil Shocks, Segment Shifts, and
 Capacity Utilization in the U.S.
Automobile Industry: What has
     changed in 30 Years?

                    By

    Valerie A. Ramey and Daniel J. Vine
  Questions Asked

1. Did gas prices affect the auto industry similarly in the 1970s and
   1980s and the 2000s?


2. Were the mismatches between capacity and demand across
   vehicle segments similar in each era?


3. How much of the decline in capacity utilization in the auto
   industry can be attributed to gas prices?


4. What margins did the automobile companies use to achieve their
   production reductions?
Overview of Events During the Past 4 Decades
                        Real Price of Gasoline
               Average of all grades, relative to headline CPI
160
140
120
100
  80
  60




       1970   1975   1980     1985    1990    1995    2000       2005   2010
            Consumer Anxiety over Gasoline Prices

     Percentage of respondents to the Reuters/University of Michigan Survey
      of Consumer Sentiment who cite high gasoline prices or shortages of
             gasoline as reasons that car-buying conditions are poor
25
20
15
10
 5
 0




     1970    1975    1980     1985     1990    1995     2000    2005     2010
10 12 14 16 18 20 22
                  8
                                     U.S. Light Vehicle Sales




                       1970   1975   1980   1985   1990   1995   2000   2005   2010
    Vehicle Market Segments


Cars (5)                Light trucks (6)

   Subcompact             Compact pickup
   Compact                Small vans
   Intermediate           Cross-utility vehicles
   Full-size              Full-size pickups
   Luxury                 Large vans
                           Utility vans
                          Domestic Sales Shares

                   Percentage of domestic vehicles sold
50




                                         45
              Small cars                         Full-size trucks,
                                                 vans, utilities




                                         40
40




                                         35
30




                                         30
20




                                         25


            Standard cars
                                              Small cars, CUVs
10




                                         20




     1972   1975   1978    1981   1984        1994   1997   2000   2003   2006   2009



            “Domestic” is defined as cars produced in North America
120
                         Domestic Days’ Supply




                                             120
         Small cars
                                                       Full-size trucks,
100




                                                       vans, utilities




                                             100
  80




                                               80
  60




                                               60
  40




                                                       Small cars,
                      Standard cars
  20




                                               40


                                                       CUVs
       1972    1975   1978   1981     1984          1994   1997   2000   2003   2006   2009



              “Domestic” is defined as cars produced in North America
Bresnahan-Ramey Measure of Capacity
Mismatch

A high dispersion in days’ supply across segments
indicates that an imbalance exists between the
composition of capacity and the composition of
demand.



                                         
              11
                  INV it
            
                                          2
  Vt   DS
                        A
                          DS it  DS tA

             i 1 INV t
                     Dispersion of Days’ Supply

             Variance of days’ supply across 11 market segments
1500
1000
   500
         0




             1975   1980   1985    1990   1995   2000    2005     2010
How do increases in gasoline prices affect the
auto industry?

3 possible effects:


1. Increase in costs of production
2. Decrease in overall sales
3. Shifts in composition of sales


(1) is probably not as important. We will focus on
   (2) and (3)
Stylized Model

Purpose:


1. To investigate various channels through
   which gas prices affect the auto industry


2. To determine conditions under which
   segment shifts can affect capacity utilization
  The Importance of the Shape of Marginal Costs

 for Segment Shift Effects on Capacity Utilization


                                                 MC
                  MC




                  MR
                                                      MR




                       Q                              Q

Linear-Quadratic Model       Capacity-Constraint Model
                          Stylized Model

The monopolist produces cars for 2 segments.

                    
        0  E 0   [ P1t S1t  P2t S 2t  Cost (t )]
                           t

                   t 0



Cost (t )    RH 1t    RH 2t      OH 1t      OH 2t
                  1                          1
                   1 ( I 1t 1  1 S1t )   2 ( I 2t 1   2 S 2t ) 2
                                           2

                  2                          2


                RH it  K , i  1, 2
                   Constraints and Demand


Inventory identity:

            I it  I it 1  RH it  OH it  S it , i  1, 2


 Demand:

  S1t  0  1P t  usegt  uaggt ,
                1                            where usegt    usegt 1   t



  S2t  0  1 P2t  usegt  uaggt ,       where uaggt    uaggt 1  t
                        Calibration


Monthly discount factor:              β = 0.997

Desired days’ supply:                 φ = 2.5 months of sales

Penalty for deviation from days’ supply: α = 0.1

Capacity:                             K = 40

Steady-state output:                  Y = 40

Elasticity of demand in S-S:          elasticity = -1.5

Autocorrelation of shocks:            ρ = 0.75
         Effect of a Negative Aggregate Shock


                 Sales                              Prices
43




                                       67
40




                                       60
37




                                       53
     0       6    12     18   24            0   6     12     18   24



         Capacity utilization                   Days' supply
                                2.54
53
40




                                2.42
27




     0       6    12     18   24            0   6     12     18   24
Effect of a Segment Shift Shock: Segment Variables


                  Sales                              Prices




                                        67
 43
 40




                                        60
 37




                                        53
      0       6    12     18   24            0   6     12     18   24



          Capacity utilization                   Days' supply
                                 2.54
 53
 40




                                 2.42
 27




      0       6    12     18   24            0   6     12     18   24
 Effect of a Segment Shift Shock: Aggregate Variables



                         Variance of days' supply
.003 .006

             0




                 0   6              12              18   24



                     Aggregate Capacity Utilization
            80
            75




                 0   6              12              18   24
Investigating the Role of Gas Prices Empirically


We now study the behavior of capacity utilization
in the data and estimate a model that allows us to
determine the importance of gas price shocks
                 Capacity Utilization

              Percent, light vehicle assembly
100
  80
  60
  40
  20




       1975   1980   1985   1990    1995    2000   2005   2010
          VAR Investigation of Gas Price Role

                       Yt  A( L)Yt 1  U t
Y consists of :

•   Consumer sentiment about gas prices
•   Days-supply of domestic cars (DS)
•   Variance of days supply
•   Capacity utilization (CU)

A(L) is a matrix of polynomials in the lag operator L.

U is a vector of disturbances.

Identification: Choleski decomposition with consumer sentiment
   ordered first.
             Effect of a Shock to Consumer Sentiment about
                                Gas Prices

                                 January 1972 to March 2009

                 Gasoline Consumer Sentiment                                       Days' Supply
  1.5




                                                                  1
         1




                                                                .5
  .5




                                                                  0
         0
  -.5




                                                            -.5
             0    6   12   18   24   30   36   42   48                0   6   12    18   24   30   36   42   48



                  Dispersion in Days' Supply                                  Capacity Utilization
  10 20 30




                                                                .5
                                                                  0
                                                            -1 -.5
         0




                                                         -1.5
-10




             0    6   12   18   24   30   36   42   48                0   6   12    18   24   30   36   42   48
Sample Stability

How has the response changed from the early period
to the recent period?



To answer this question, we estimated the VAR over
two subsamples:

1972 – 1989,    1990 – 2009
                    Effects Estimated Over Different Subsamples



                    Gasoline Consumer Sentiment                                     Days' Supply
           1




                                                            .2 .4 .6
                                                                                               1990-2009
  .2 .4 .6 .8




                                                                   0
                                                            -.2
           0




                0    6   12   18   24   30   36   42   48              0   6   12    18   24   30   36   42   48



                     Dispersion in Days' Supply                                Capacity Utilization
  10 20 30




                                                            .5                 1972-1989
                                                                   0
                                                            -.5
           0
-10




                                                            -1




                0    6   12   18   24   30   36   42   48              0   6   12    18   24   30   36   42   48
Relative Importance of the Aggregate Channel
vs. the Segment Shifts Channel
How does the response of capacity utilization to gas prices change
if we shut down the particular channel?

To answer this question, we perform the following counter-factual
experiment:

•To shut down the aggregate channel, we simulate the estimated
VAR, not allowing aggregate days’ supply to change.

•To shut down the segment shifts channel, we simulate the
estimated VAR, not allowing the dispersion of days’ supply to
change.
                    Effects of Gasoline Sentiment Shock:
                               Counterfactuals

                  Constant Days' Supply                           Constant Dispersion of Days' Supply
      0




                                                              0
                                                                           counterfactual
-.2




                                                        -.2
                  counterfactual
-.4




                                                        -.4
-.6




                                                        -.6
                                                                                          baseline
                                   baseline
-.8




                                                        -.8




          0   6     12   18   24    30   36   42   48              0   6   12   18   24   30   36    42   48
Importance of Gas Price Shocks to Capacity
Utilization

How important have gas price shocks been to capacity
utilization during particular historical periods?



To answer this, we decompose the movements in
capacity utilization into those due to gas price shocks
versus other shocks.
Historical Movements in Utilization and Dispersion
How the Detroit 3 Changed their Production


We use the plant level data collected by Bresnahan
and Ramey (1993) and Ramey and Vine (2004, 2006)
to study the margins of adjustment of the Detroit 3.
Margins of Adjustment used to Curtail Auto Production
Detroit 3 Firms; North American Production by Model Year


                               Percent share of adjustment attributable to . . .


                Change in
Peak   Trough   Production     Overtime         Inventory         Linespeed        Shift     PlantExit/
(MY)    (MY)    (millions of       Hours        Adjustments       Changes          Changes   Entry
                     units)


1973   1974         -1.4            17                42               15            31          -5


1979   1982         -4.7             8                19                7            45          28


1999   2001         -1.9            44                30               -5            13           8


2002   2006*        -3.1            13                12               36            13          55
                                 Isolated Margins of Adjustment:
                                Detroit Three Motor Vehicle Output

                                                    Overtime Hours
              1600
Thousands of units




              1200

                     800

                     400
                       Jan-72   Jan-76   Jan-80   Jan-84     Jan-88   Jan-92   Jan-96    Jan-00    Jan-04



                1600                                       Temporary Closures
Thousands of units




                1200

                     800

                     400
                       Jan-72   Jan-76   Jan-80   Jan-84     Jan-88   Jan-92   Jan-96   Jan-00    Jan-04
                                           Isolated Margins of Adjustment:
                                          Detroit Three Motor Vehicle Output

                1600
                                                                          Shifts
Thousands of units




                1200

                          800

                          400
                               Jan-72     Jan-76    Jan-80     Jan-84     Jan-88      Jan-92   Jan-96   Jan-00   Jan-04



                          1600
                                                                  Plant Entry/Exit
          Thousands of units




                          1200

                               800

                               400
                                 Jan-72    Jan-76     Jan-80     Jan-84      Jan-88      Jan-92    Jan-96   Jan-00   Jan-04
Conclusion
   In many ways, the effect of gas prices on the
    auto industry during the last 10 years has
    been similar to the effect during the 1970s
    and 1980s.

   Shifts in demand across segments continues
    to be an important channel for the effect of
    gas prices on the auto industry.

				
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