The Impact Of Economic Forces On The Allocative Efficiency Of Passenger Car Market Of Bangalore, Karnataka.

To what extent do various economic forces contribute to the optimum allocation of resources in the passenger car market of Bangalore, after 2018?

The automobile sector is an important indicator of economic growth in Indian economy and plays a significant part in the manufacturing sector of an economy. The Indian automobile sector is also the main contributor to the country’s manufacturing gross domestic product (GDP) and its contribution to the country’s GDP has increased from 2.77% in 1992-93 to 7.1% in 2017 and up to 49% of the manufacturing sector’s GDP (2016). Indian automobile sector is also one of the main sources of country’s export revenue and employment. In the year 2017-18, Indian automobile sector produced approximately 29 million vehicles, making it the sixth largest producer of automobiles globally, attracting many multinational corporations, meeting the domestic and international demands for automobiles. The Indian automobile sector is essentially divided into four segments. Namely, commercial vehicle, three-wheeler vehicles, passenger vehicles and two-wheeler vehicles.

However, during the last decade, due to the rise in the population and the real income of larger masses, the automobile market had been expanding at an unprecedented rate. The domestic sale of passenger vehicles in India has increased by 9.76% between 2011 and 2018. Increasing consumption of passenger cars not only lead to heavy pollution and emissions, but also has resulted in severe traffic congestion in major cities of India. The exponential growth of automobile industry is attributed to many factors, from the Indian government’s macroeconomic policies, growing working population and their increase in real income to the urbanization trend across India. This growing demand has helped India set its ambitious automotive mission plan 2016-26 to increase the automobile sector’s contribution towards the country’s GDP by 12%.

However, since 2018, the world’s automobile industry is facing some unexpected downward trend and India is no exception to this. In 2019, the sale of all categories of vehicle dropped by 18.71% from the previous year. The most adversely affected is the domestic passenger vehicles; the domestic sale has dropped by 12.7% in 2019 vis a vis 2018. Multiple reasons have contributed towards this fall in demand for passenger vehicles in India. Some reports have claimed that the change in government policies, such as new safety norms are responsible for this declining sale of passenger vehicles while other reports blamed the fall in consumer’s purchasing power due to various reasons for this declining trend in car sales.

As to the downward trend in the Automobile Industry, Bangalore passenger car market is chosen for research. It because Bangalore is the 4th largest tech cluster in the world and has committed to emerge as the automobile capital of India. The city has also created 12 lakh jobs in the last four years, while the top talent the world has to offer constitutes 70% of the city’s population. Average consumers in Bangalore can be considered as true representatives of consumers in India and economic factors causing the decline in sales can be investigated by analysing different factors responsible for the drop in passenger car sales in Bangalore. Different factors influencing the consumer and the producer behaviour like the change in real income, major substitutes like metro trains, shared rentals, increasing fuel prices, work from home culture, Government policies and/or legislation on pollution, road safety, parking rules, traffic congestion etc. are studied to assess the impact of the equilibrium price and quantity of Cars in the Bangalore passenger car market.

However, the last two years were characterized by a twist in the turn of the overall consumption in the Bangalore automobile market, as it crossed 80 lakh, which has overtaken Mumbai (36 lakh), Hyderabad (52 lakh),  and Chennai (56 lakh), is now only behind Delhi’s market(1.5 crore) which has three times the road length of Bangalore. To value public health over private vehicles, 6000 BMTC buses in Bangalore city contribute less than 1% of the traffic on the road, while the private vehicles (90% of them cars) contribute to the major chunk of it. which louds for a regulation like congestion tax, high registration and parking fees etc. The study on these market and government forces helps to assess the impact of the passenger car sales, which in turn assess whether the output is at a socially optimum level or not.

Hence the following research question was formulated: “To what extent do the market forces contribute to the optimum allocation of resources in the passenger car market of Bangalore, after 2018?”

It can be hypothesised that the main reason for the fall in demand is the macroeconomic environment of low economic growth along with increasing unemployment in India which has lowered consumer confidence to buy first-hand passenger vehicles in the city. Other macroeconomic factors include the implementation goods and service tax (GST) and the difficulty in obtaining car loans due to the central bank’s regulation of commercial banks in India. Another major factors which has played a role in the fall of passenger cars’ sale is the Indian government’s regulatory policy for Bharat stage IV, along with an increase in the cost of cars due to additional regulations. Along with that, factors like increasing availability of shared vehicles and public transport, new motor vehicle acts, high insurance and registration costs are also responsible for this declining sale of passenger cars in Bangalore.

To answer this research question, a combination of data from primary and secondary sources will be analysed. For primary research, interviews with two car dealers of different brands were conducted. These interview have helped understand the recent trend in consumer demand for passenger vehicles in Bangalore. This has also helped understand the challenges faced by the dealers in terms of availability of car loans and how different government regulations have impacted consumer’s purchasing decisions regarding passenger cars. A consumer survey done on the existing and potential car consumers with separate questionnaire survey for the private and taxi car users, gives updated and broad qualitative data on consumer behaviour. However, these interviews and surveys were not sufficient to understand the challenges faced by the automobile manufacturers in terms of costs of production, taxation and other government regulations. In order to overcome this problem, different research papers from journals were analysed. Reports from different international organisations have helped understand the reason behind the declining sales and has helped determine which factors play a major role.

In order to obtain quantitative data, official reports published by the state government were critically reviewed. These reports have helped obtain data regarding car sales, change in job market and GDP. However, state government publications in many fields were not updated for the recent years. To overcome this issue, sales report for the past 5 years from two automobile dealers were obtained through primary research. The Economics textbook by Ellie Tragakes, and Jocelyn Blink were thoroughly read to understand different macroeconomic theories like recession, unemployment and low economic growth as well as the microeconomic theories of market demand and supply.

There has been an exponential increase in population since the year 2000, which is also projected in to the future. Although, there is immense potential for sellers and buyers, a proportionate increase in the consumption of cars may not be desirable for the Bangalore society, as it may lead to further emissions, pollution, congestion etc. Therefore a change which is not much correlated to the population control may represent the optimum quantity of passenger cars sold in the Bangalore Market.

As shown in the Fig 4 & Fig 5, the annual growth rate of all automobiles is falling, with a relatively steeper fall in the Taxi’s use. This trend is shifting with the Bangalore city hosting 8 million vehicles; out of which, majority are passenger cars. From fig.4 shows the market share of the passenger cars in India, makes it evident that this is an oligopolistic market.

Impact of the implementation of GST on the Bangalore Auto Market

The implementation of Goods & Services Tax (GST) on 1st July 2017 had some impact on the consumption of passenger cars in the Bangalore city. The effective tax rates before and after the different segments of passenger vehicles indicate a mixed impact on their prices

Effective tax rate reduces for all passenger vehicles (except the hybrid). This reduction in the cost might increase the supply of cars in the market, at reduced prices.

Findings from the survey of daily commuters in the Bangalore city

A survey conducted on randomly selected daily commuters in the Bangalore city revealed the fact that nearly 60% of them are consumers of the passenger cars, 30% having their own vehicle and around 27% using either rental or shared taxi cars.

The major factors influencing the above distribution of the daily commuters’ choice of the transport means are the Traffic congestion and the parking difficulties, followed by cheaper alternatives. So their perception on the petrol prices is also a notable reason on the choice of the mode of transport as illustrated in fig. 6, below.

Fig 6 reveals the fact that none of the daily commuters feel petrol prices are cheap and 87% of them perceive the prices are high, with a merely one eighth of them feel the petrol prices are affordable on a daily basis. This means, even the passengers using their own car for daily commuting are sensitive to the petrol prices, which makes it a significant component to analyse.

Analysis of Market failure in the Bangalore Passenger Car Market

There is a market failure in the Bangalore Passenger car market, as it is grossly over provided in the market, due to the increased demand for private vehicles and taxis. The increased consumption of passenger vehicles creates a spill over cost, illustrated as the market demand curve D = MPB, where the MPB>MSB. This causes the welfare loss, represented by the shaded region in the diagram. By internalizing the external cost of pollution and traffic congestion, the welfare loss can be corrected, as the MPB curve can be brought down to the extent to which MSB = MPB.

Various factors impacting the correction of the consumption externalities in the passenger car market, can be categorized under the consumer behaviour (demand side) and producer behaviour (supply side), for further analysis.

Analysis of the consumer behaviour only

Most of the factors discussed in the introduction, impacts either the consumer or the producer behaviour, each of which are represented by the Demand and supply curve, consecutively. The changes in the demand and supply due to these factors, enables the analysis of the market mechanism, as to what extent it is auto-correcting the market failure to gain the allocative efficiency.

The overall impact of the fall in income, economic downturn, increasing traffic congestion and the related delay in commuting (especially during the peak hours), availability of cheaper means of daily commuting like the public transport (metro/trains, KSRTC buses etc.), rental cabs/ car-pooling (Ola, Uber etc.), rickshaws and self-owned bikes etc. shift the demand curve downwards systematically, from D1 to D2, as shown in the Figure 10. WFH culture and the reduced frequency of commuting of professionals and the lack of parking space and the tight restrictions on car parking also fuel the fall in demand for passenger cars.

Demand for petrol is seemed to be inelastic. However, the Cross-elasticity of Demand (XED) of passenger vehicles with the prices of Petrol as a complementary good is high, as evident in the Fig. 6. Therefore, higher fuel prices may significantly reduce the quantity of the passenger cars consumed by the daily commuters, as illustrated in the Figure 12.

Any response to market changes, may require the producers to change the proportion of their factors of production, which can happen only in the long-run. Therefore, the analysis of producer behaviour in the long-run, as a response to the short-term changes in the market is inevitable to assess the extent to which the price mechanism can function to efficiently allocate the production resources.

Analysis of the producer and consumer behaviour

Leftward shift in Demand leads to lower prices, which might eventually increase the quantity demanded. However, prices cannot be kept lower, due to the congestion charges and the upward pressure of prices for suppliers due to transition to the production of BS4 in 2017 and the BS6 engines in 2020. Cost push inflation also led to a shift in the supply curve to the left. However, the curve S represents an increase in the supply of the cars to the market, due to the fall in the effective taxes on almost all the Passenger car segments, due to the implementation of GST, as shown in the Figure 7. The fall in indirect taxes (GST) acts as negative taxes, and the increase in the taxes of hybrid vehicles decrease their consumption and hence loses the benefit of reduced pollution. This incentivises the producers to allocate more resources towards the production of passenger cars. Increased supply of cars reduces the prices, leading to an extension in demand for passenger cars, thus widening the negative externalities.

A study on the allocative efficiency based on the market structure is important at this clare 

Analysis of the efficiency in the Bangalore Passenger Car market

The free market mechanism assumes an auto correction of the any anomalies in the market, without government intervention, which is explained by the Adam Smith’s idea of “invisible hand”, which means the dynamic interaction between the market forces of demand (D) and Supply (S) through Price Mechanism, assumes to allocate the resources in the most socially desirable manner.

Analysis of the Market Structure of Bangalore Passenger Car Market

As the Market is non-collusive Oligopolistic in nature, which gives the producers, a chance to informally collude towards fixing higher price, agreeing for non-price competition. Tacit or informal collusion of the leading firms like Tata, Maruti Udyog limited, Hyundai etc. in the passenger car market, may lead to price leadership, where the dominant firm sets the price and others follow suit. None of them have the incentive to cheat and reduce the price, as a price reduction will force all major firms to reduce the price. If the dominant firm wants toincrease in price, others may not follow, making them loosing there market power eventually. Thus the price of the passenger cars remains relatively stable in the market.

Therefore, each firms may enter into non-price competition like branding to get dominance in the market. The price becomes sticky, as shown in the Figure 6. which might fix the prices well above the possible market price, forcing a fall in the demand for passenger cars

Each firm produces at the profit maximizing output Qe, which represents an output where MC = MR. At the output MC = AR = D, the market achieves allocative efficiency, means the market output is lower than the optimum level, due to the higher sticky prices. This contracts the market demand to some extent, as the passenger car market is relatively price elastic, indicating an auto-correction of the market failure.

The impact of some macro-economic variables on the allocation of resources in the Bangalore passenger car market cannot be ignored.

Analysis of Macro economic variables affecting the producer behaviour

The major macro-economic varibles which may significantly influence the producer behaviour are the unemployment, labour market rigidities and the inflation. Government policy responses to the macro-economic changes can also impact the producer decisions. Over a period of time (mostly in the long-term), the economy recovers, as a result of which the unemployment decreases and the consumer disposable income increases.

If not up to P2, in Figure 11, the suppliers may be forced to increase price to a certain extent, due to the cost-push and demand pull inflation, both happening in the recovery stage of Business Cycle, there is an uneven pressure on the producers to keep the prices to cover-up the costs and to capitalize on the increasing consumer demand.

Furthermore, the wage and so price rigidities may also act as an upward pressure on the car prices. Wage rigidities are those factors like Labour Union engagement, minimum wages legislation etc., which make the workers less flexible to offer their labour below certain wages. As the major factor cost- wages become inflexible, price also turns out to be the same, owing to a short-run trap in the economy, countering the price mechanism to function freely. Therefore, the allocative efficiency is not likely to happen as natural with the invisible hand, in the long run.

The Research Question focus on the allocation of resources in the Bangalore market for cars based on a range of economic factors. The factors affecting the allocation of resources are broadly studies under the consumer and producer behaviour, Market structure and the firm’s behaviour in the market of passenger cars and the macro economic variables like the economic growth, change in disposable income, unemployment, inflation and the stages in the business cycle, all of which may impact the allocation of resources. Micro-economic variables studied includes the collusion and competition on the oligopolistic market, demand, supply, price, price elasticity and other determinants of demand etc.

The data collected from primary sources are classified on the demand and supply-side. The consumer (existing & potential) survey done differently for the private and taxi car users gave the inputs on the study of consumer behaviour, while the data collected from the interview with 2 major car dealers gave valuable inputs on the producer behaviour. An extensive secondary research using news and research articles and online reviews and charts revealed more data to analyse the market structure and the macro-economic variables, apart from strengthening the study on  consumer and producer behavior.

Analysis starts on the market structure and the possibilities of an informal collusion which forces the prices to be inflexible to limit the production and consumption of the cars, thus naturally preventing the over-allocation of resources. This will be evaluated further with the help of consumer and producer behaviour. The consumer behaviour is studied with price elasticity and non-price determinants of demand affecting the shifts in the demand for passenger cars in the Bangalore market. Further study on producer behaviour evaluates the producer’s response to the market changes and the extent to which it can correct the consumption externalities in the market. A further study on the Macro economic variables using the Business Cycle, gives a different perspective towards those factors which are beyond the control of the demanders, suppliers and even the government, which can have a huge impact on the allocation of resources in the Bangalore passenger car market. The study concludes that, in the short-run, the resultant impact of different economic forces in the market is bringing a noticeable change in the allocation of production resources, although it is not reallocated to a socially desirable level on production and consumption of the cars. The assessment of the allocative efficiency in the long-run may require even finer and continuous research.

The study is limited to a few selected respondents from consumer and supplier side.

However, use of secondary data helps to cover up this to a large extent. The possibility of the media bias and the limited research literature may also prove as a limitation to arrive at a cut and right judgement on the allocative efficiency, even in the short-run.

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Question 1 -  Was the year 2019-20 good for your sales? What was particular in the financial year?

Maruti Dealer: The year was all a mix of good and bad. Sales during the first three quarters were fairly good, but not the same in the last quarter. This is the year when Maruti stopped their diesel variants for the small cars and has started with the new models with BS6 Engines, as per Government regulation.

Tata Dealer: The year was very significant for Tata Motors as all the cars got a place among the top 10 Cars in the crash test rating of Global NCAP, with Tata Nexon ranking the First. There were increased enquiries and sales during this year. However, the sales declined during the lockdown, because of which the overall sales were affected.

Question 2 -  How have the competition been in the market for the last two years?

Maruti Dealer: The competition increased heavily during this time, which had a pressure on giving more discounts and extra services from the dealer side. Also, the customers are more conscious and demanding in terms of price, benefits, quality, safety and the additional services.

Tata Dealer: Almost similar to the above response….

Question 3 -  Are you selling more of Taxis or personal cars? How about the other?

Both: Personal Cars. Taxis are significantly less (Tata has more of taxis sold than Maruti)

Question 4 - What proportion of your customers are buying cars for the first time? Are others exchanging the cars or buying another car?

Maruti Dealer: Most of the customers are not new, though some of them are moving from a bike to a car. Some of them are buying a car from a higher segment, while others switching their brand. A reasonable proportion of the customers are exchanging their old car for a new one and demanding good exchange offer. A few of the customers are new too.

Tata Dealer: Most of the customers are switching from a different segment or a brand. A few of them are exchanging the cars, but generally less.

Question 5 - How has your profit margins changed during the last two years?

Both: Because of various reasons, the profit per cars are falling during this time. May be due to the changes from BS4 Engines to BS6, high competition and many of the consumers becoming more demanding and sensitive towards prices, due to their falling income. EMI payments are also pending for some of the months. Lockdown has acted even worse.

Age:

Occupation:

Question 1 - How many cars do you own?

a] 1

b] 2

c] 3

d] 4/more

Question 2 - What mode of transport are you using for daily commuting to office

a] Own car

b] Two wheeler

c] Rentals/shared

d] Train/Metro/KSRTC

e] Any other, specify

Question 3 - Answer only if you are not using a personal car for daily commuting. From the reasons listed below which is/are relevant reason/s for your choice of the mode of transport.

• Using own bike for daily commuting
• Traffic congestion and time/risk involved in travelling inside the city
• Availability of other (cheap 7 easy) modes of transport –like metro trains, buses
• Availability of substitutes – rentals/ car-pooling (Ola, Uber etc.) and others
• Increased WFH culture, reducing the frequency of commuting
• Stringent rules on Car parking and lack of enough space
• Increased taxes, insurance and increasing fuel prices

What is the major reason for you to choose the above means of transport for daily commuting? (response to this part of the question is compulsory)

Question 4 - How do you rate the current fuel prices.

a] Cheap

b] Affordable

c] High

d] Very High

Question 5 - In a 5 point scale, how inconvenient you feel driving in the  Bangalore city (1 being convenient and 5 being very inconvenient) OR In a 5 point scale, how inconvenient do you feel the traffic congestion in the  Bangalore city is (1 being convenient and 5 being very inconvenient)

a] 1

b] 2

c] 3

d] 4

e] 5

Question 6 - How many cars do you own?

a] 1

b] 2

c] 3

d] 4/more