Economic Analysis Report - Tesla

Introduction

Tesla, Inc. is a globally renowned company primarily recognized for its electric vehicles (EVs), solar energy products, and energy storage solutions. Tesla has also made strides in artificial intelligence and robotics. I chose Tesla for this analysis because of my connection to the company as a former employee and my interest in the rapidly expanding EV market. Tesla's innovations in battery technology, energy efficiency, and self-driving capabilities have revolutionized the automotive industry, making it a leader in sustainable energy solutions.

Comparative Advantage and Specialization

Tesla's primary competitive advantage lies in its technological innovations and manufacturing capabilities, especially its Gigafactories. These factories have allowed Tesla to scale production while focusing on reducing battery costs and improving efficiency. Tesla's specialization in electric vehicles and its strong partnerships with lithium and other battery components suppliers have made it a dominant player in the industry.

Price Elasticity

Tesla’s demand shows a tendency toward being elastic. One of the determinants of price elasticity for Tesla is the availability of substitutes. With the entry of more affordable electric vehicles like the Chevy Bolt, Tesla has lowered its prices to remain competitive. This price elasticity is evident as Tesla has reduced its prices, which has increased overall demand despite lowering the price per unit. Additionally, Tesla's electric vehicles are considered luxury goods, making them more sensitive to price changes. For instance, whenever Tesla reduces its prices, there is a significant uptick in demand (Assis, 2023).

Government Policies and Price Equilibrium

Government policies such as the CHIPS Act significantly influence the supply and demand equilibrium for Tesla’s products. The CHIPS Act provides monetary incentives for semiconductor manufacturing in the United States, which helps reduce costs for Tesla's electric vehicles. Additionally, government tax incentives for electric vehicle purchases have boosted demand. For example, the U.S. government offers up to $7,500 in tax credits for clean vehicle purchases, further increasing Tesla’s consumer surplus (U.S. Department of Commerce, 2024; Internal et al., 2024).

Costs of Production and Decision Making

Tesla faces both variable and fixed costs in its production processes. The company’s fixed costs include factory operations and investments in research and development, while variable costs involve raw materials, especially lithium and other battery components. Tesla has reduced production costs through technological advances, allowing it to increase its profit margins. Tesla makes short-term production decisions based on demand fluctuations and material costs. For instance, when faced with material shortages or rising costs, Tesla refines its battery composition to reduce dependency on costly resources (Izsevim, 2024).

Market Structures

Tesla operates in an oligopolistic market, particularly in the electric vehicle (EV) industry, competing with dominant firms like Ford, GM, and Volkswagen. In this type of market, a few large firms hold significant market power, creating high barriers to entry and exit, such as the need for massive capital investments, advanced technology, and supply chain management. These barriers protect established companies like Tesla from potential new entrants, limiting competition.

Profitability in Oligopolies

In the short run, oligopolistic firms like Tesla can achieve profitability by differentiating their products and using strategic pricing. Tesla employs a premium pricing strategy, focusing on product innovation, brand loyalty, and technological advancements rather than engaging in price competition. This allows Tesla to maintain high-profit margins, similar to Apple in the smartphone industry, which avoids price wars through product differentiation (Varian, 2010). In the long run, firms in oligopolistic markets must continuously innovate and differentiate to sustain their profitability, as competitors may eventually catch up or introduce new innovations.

Profit-Maximizing Quantity and Pricing

In an oligopolistic market, the profit-maximizing quantity is determined where marginal revenue (MR) equals marginal cost (MC), like monopolies and monopolistic competition. However, due to interdependence between firms, companies like Tesla must also consider the expected reactions of competitors when setting production quantities and prices. Game theory often determines prices in oligopolies, where firms analyze their competitors' potential responses before making decisions. For example, Tesla may refrain from lowering its prices, knowing that competitors like Ford or GM could react by cutting prices, reducing profitability across the industry (Shapiro & Varian, 1999).Like other firms in an oligopoly, Tesla is a price maker due to its control over product differentiation and technological leadership. This contrasts with perfect competition, where firms are price takers because no individual firm can influence the market price.

Inefficiencies in Monopolies and Monopolistic Competition

Monopolistic and oligopolistic markets tend to result in allocative inefficiency, where the price exceeds marginal cost, reducing consumer surplus. For instance, while justified by superior product quality, Tesla's premium pricing results in higher prices for consumers compared to what they might pay in a more competitive market. Additionally, monopolistic competition, which features many firms offering differentiated products, leads to productive inefficiency, as firms do not produce at the lowest possible cost due to their focus on non-price competition. An example from the textbook is the airline industry, where firms differentiate services, but high operating costs prevent them from achieving the lowest unit costs (Mankiw, 2024).

Pricing in Oligopolistic Markets

Firms in oligopolistic markets set prices strategically to avoid price wars. Tesla’s strategy exemplifies this approach, focusing on maintaining its premium image rather than undercutting competitors' prices. This mirrors the behavior of other tech giants, such as Apple, which maintains premium pricing through product differentiation and innovation. By doing so, Tesla avoids aggressive price competition, which could hurt its profitability and that of the industry (Varian, 2010).

Microeconomics Principles and Business Decisions

Microeconomic principles are crucial for Tesla’s decision-making processes. Trends in supply and demand, price elasticity, and government policies influence how Tesla sets prices and invests in innovation. Tesla’s ability to adapt to changing market conditions, such as rising material costs or shifts in consumer preferences, will continue to impact its future business decisions.

References

Assis, C. (2023, May 23). Tesla price cuts are working as demand increased, analyst says. Market Watch. Retrieved from https://www.marketwatch.com/story/tesla-price-cuts-are-working-as-demand-increased-analyst-says-618447df

Internal Revenue Service. (2024, August 8). Credits for new clean vehicles purchased in 2023 or after. A U.S. Government Website. Retrieved from https://www.irs.gov/credits-deductions/credits-for-new-clean-vehicles-purchased-in-2023-or-after

Izsevim, I. (2024, July 16). Tesla's EV battery production and global Gigafactory network. Automotive Manufacturing Solutions. Retrieved from https://www.automotivemanufacturingsolutions.com/ev-battery-production/teslas-ev-battery-production-and-global-gigafactory-network/45873.article

Shapiro, C., & Varian, H. R. (1999). Information rules: A strategic guide to the network economy. Harvard Business School Press.

U.S. Department of Commerce. (2024, August 09). Two years later: Funding for the CHIPS and Science Act is creating quality jobs, growing local economies. U.S. Department of Commerce. Retrieved from https://www.commerce.gov/news/blog/2024/08/two-years-later-funding-chips-and-science-act-creating-quality-jobs-growing-local

Varian, H. R. (2010). Intermediate microeconomics: A modern approach (8th ed.). W. W. Norton & Company.