Explain how a rational consumer decides whether to buy an electric vehicle, and how a rational producer of electric vehicles determines their output level.
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To make transport greener, Singapore will accelerate the adoption of electric vehicles. During Budget 2020, it was announced that the country would gradually phase out internal combustion engine vehicles by 2040. Since then, the government has provided "significant" incentives for electric vehicle adoption.
(a) Explain how a rational consumer decides whether to buy an electric vehicle, and how a rational producer of electric vehicles determines their output level. [10]
Consumers
Rational consumers seek to maximise their utility (satisfaction) subject to their budget constraints. When deciding whether to buy an electric vehicle (EV), a consumer will weigh the expected benefits (utility) against the costs, including the price of the EV, running costs, and opportunity costs such as forgoing other expenditures. This decision is guided by the marginalist approach, where the consumer evaluates the marginal utility (MU) of purchasing an EV relative to its price.
Consumers derive utility from various factors. For an urban consumer concerned with environmental sustainability and rising fuel costs, the utility from owning an EV may come from reduced fuel expenditure, lower maintenance costs, and contributing to lower carbon emissions. Additionally, EVs may offer cost savings through government subsidies or tax breaks, further enhancing their attractiveness. Consumers may also consider the convenience of charging infrastructure and the range of the EV before making a decision.
The marginal utility for a rational consumer may also stem from the EV's features, such as advanced technology, smoother driving experience, or lower noise pollution compared to traditional vehicles. A rational consumer will choose to buy an EV if the perceived marginal utility exceeds or equals the total costs, including both the upfront price and long-term running costs. Conversely, if alternatives (such as fuel-efficient hybrid cars or public transport) provide higher utility at a lower cost, the consumer may decide not to buy an EV.
Budget constraints play a key role in the decision-making process. Even if an EV provides significant utility in terms of environmental benefits and cost savings, the consumer must ensure that the purchase is affordable. If the EV's price is too high relative to the consumer’s income, or if the consumer must sacrifice higher-utility goods or services, they may postpone or forgo the purchase.
Producers
Producers, according to economic theory, aim to maximise profits, which are the difference between total revenue (TR) and total cost (TC). In determining the optimal level of output, producers of electric vehicles employ the marginalist principle of equating Marginal Cost (MC) with Marginal Revenue (MR). Profit maximisation occurs at the point where the cost of producing one more unit of an electric vehicle (MC) is exactly equal to the revenue generated from selling that additional unit (MR).
When MC > MR: If the cost of producing an additional electric vehicle exceeds the revenue it generates, the firm is not profit-maximising. In this case, producing more EVs would result in losses. Therefore, producers will reduce output to avoid further financial losses and maintain efficiency.
When MR > MC: If producing an additional electric vehicle brings in more revenue than it costs to produce, the firm can increase production to boost profits. This scenario suggests that the producer should expand output to take advantage of the higher profit margin generated per unit.
Profit Maximisation (MC = MR): The firm reaches the optimal level of output when the cost of producing one more electric vehicle is exactly equal to the revenue it generates. At this point, profits are maximised because the firm is neither losing money by overproducing nor missing out on potential profits by underproducing.
In the context of the electric vehicle market, producers face variable production costs such as the price of batteries, raw materials like lithium and cobalt, labour costs, and fixed overheads. For example, if a technological breakthrough reduces the cost of producing EV batteries (a decrease in MC), producers may increase output as each additional unit becomes cheaper to produce. Similarly, if consumer demand for electric vehicles rises due to factors like increased environmental awareness or government incentives (resulting in higher MR), producers will expand production to meet the demand while maintaining profit maximisation.
Conversely, if input costs rise due to a shortage of key materials like lithium, or if demand falls (resulting in lower MR), producers will scale back production to avoid inefficiencies, ensuring that they remain at the MC = MR equilibrium for profit maximisation.
In summary, both consumers and producers of electric vehicles act rationally by applying marginalist principles to weigh costs and benefits. Consumers seek to maximise utility within their budget constraints, while producers aim to maximise profits by equating marginal cost with marginal revenue. This rational behaviour ensures efficient decision-making in the electric vehicle market.