6 Economies of Scale and Product Viability
Jessie Martinez
The signs of global warming have become widespread and clear causing many new car buyers to evaluate alternatives to the traditional Internal Combustion Engine(ICE) vehicle. All electric vehicles(EV) sales in the United States have increased by multiples from 0.2% of sales in 2011 to approximately 5% in 2023. While still a small share of the market, it is clear EV sales will continue to grow in the long term.
Suburban Utility Vehicles (SUV) is the largest category of auto sales in the United States. A traditional ICE SUV cost on average $28,739 to purchase in 2018. The average price in 2023 was $35,172. All electric vehicle average price in 2018 was $67,004 and has declined to $58,940 in 2023 (Cruz 2023). How did the price of electric vehicles fall when the price of ICE SUV vehicles increased? Economies of Scale.
Production Economies of Scale occur when the average cost of production declines due to producing at higher volumes that can take advantage of efficiencies. Initial higher cost in EV production due to investment in manufacturing technology and battery cost were incurred to produce low volume. However, battery cost while still significant, has declined 85 percent over the last decade as sales have increased. Battery production has gotten better as more resources are dedicated to achieving efficiencies. Forecast show EV production cost declining as EVs are simply easier to produce as they have fewer parts. According to Interplex.com, ICE powertrains have over 200 parts while EV’s on average have less than 25. Fewer people with more automation, and lower battery costs, will lower production cost long term. Production cost, for now, still needs to decline further as only a few upscale models are actually profitable for the auto companies. You read that right, companies are losing money producing EVs. Greater economies of scale are needed and can be reached, however, market share has to increase. This is hard to do when the average EV price is $10,000 plus more than the average ICE vehicles. Even with $7,500 in government subsidies EV sales can be difficult with cheaper ICE alternatives and consumer range anxiety. Increased consumer education, expanded charging network, new production technology, and increasing efficiency in utilization of battery rare earth metals have auto companies optimistic that long term sales growth will allow them to achieve significant economies of scale and make the EV market profitable.
Questions:
- Why has the price of new EV’s fallen recently?
- What are some of the reasons why consumers are not yet willing to purchase an EV?
- Find a new auto company (2022 or later) that is specializing in EV production. What is their current profitability forecast?
- Why would companies sell cars knowing they will not make a profit?
- Find another example of an industry or company that has achieved economies of scale that has resulted in lower prices for consumers.
References:
Cruz, Angelique (2023) How much does a New Car Cost? https://www.moneygeek.com/insurance/auto/average-price-of-a-new-car/
Rapson, David & Erich Muehlegger (2022) The Economics of Electrical Vehicles. Working Paper 29093. National Bureau of Economic Research
Paoli, Leonardo (2022) Electric cars fend of challenges to more than double global sales. https://www.iea.org/commentaries/electric-cars-fend-off-supply-challenges-to-more-than-double-global-sales