Tesla and Principles of Microeconomics 1

Tesla and Principles of Microeconomics

Jared Taylor
Clark College

Author Note
This paper was prepared for Microeconomics 201, taught by Professor Atkinson.
 Tesla and Principles of Microeconomics 2

Most of the topics throughout Paul Krugman and Robin Wells book, Principles of

Economics 4th edition try to relate to real world industries and companies in order to explain

microeconomics. So, after their effort to make their book relatable to real world industries and

companies a question remains. Is there a company that exemplifies topics within the book,

Principles of Economics 4th edition by Paul Krugman and Robin Wells? One company that

easily allows for these concepts to be compared to and expanded upon is Tesla. To demonstrate

this we will examine Tesla’s attributes to expand on the ideas of supply and demands concepts,

the four major market types, various production costs, and concepts of price, income, and cross-

price elasticities.

First, we will define and explain various supply and demand concepts based off the Paul

Krugman and Robin Wells book, Principles of Economics 4th edition. To begin we will explain

what a supply and demand model is and how it works. In Paul Krugman and Robin Wells book,

Principles of Economics 4th edition, Krugman and Wells (2015) explain that the supply and

demand model is a model that “illustrates how a competitive market, one with many buyers and

sellers, none of whom can influence the market price, works.” (pg. 98). And looking further into

the model Krugman and Wells (2015) point out how in a supply and demand model there is a

demand curve that shows the “Quantity demanded at any given price” (pg. 72) and a supply

curve that “shows the relationship between quantity supplied by price” (pg. 79). Krugman and

Wells (2015) also point out how there are five main variables that shift the demand curve, “a

change in prices of related goods or services such as substitutes or complements” (pg. 98), “a

normal change in income” (pg. 98), “a change in tastes” (pg. 98), “a change in expectations” (pg.

98), and “a change in the number of consumers” (pg. 98). Krugman and Wells (2015)

additionally point out the five variables that make the supply curve shift, “A change in input
 Tesla and Principles of Microeconomics 3

prices” (pg. 98), “a change in the prices of related goods and services” (pg. 98), “a change in

technology” (pg. 98), “a change in expectations” (pg. 98), and “a change in the number of

producers” (pg. 98). Krugman and Wells (2015) make it very clear that when and if these

variables are manipulated the companies involved in supplying any given product move towards

equilibrium price which they define as, “the price at which the quantity demanded is equal to the

quantity supplied” (pg. 98)

So how are the supply and demand concepts then applicable to an automotive company

like Tesla? To start, Tesla has many manufacturing problems which has left them with a snail’s

pace shift to the right with their supply curve which hasn’t allowed them to keep up with the

demand for their products. Lora Kolodny, a tech reporter for CNBC expands on Tesla’s issues

with producing their vehicles in the article “Tesla employees say to expect more Model 3 delays,

citing inexperienced workers, manual assembly of batteries”. In the article Kolodny (2018)

points out how they have problems with production and problems with quality because of how

they are, needing to make their batteries by hand, and borrowing employees from their suppliers

to help manually assemble their batteries (Koldony, 2018). This is especially a problem because

as their demand curve continues to shift to the right for their products, which Kolodny also

discusses. Kolodny points out how “Tesla’s future as a mass-market carmaker hinges on

automated production of the Model 3, which more than 400,000 people have already reserved,

paying $1,000 refundable fees to do so.” (Koldony, 2018). Tesla can relate to the concept of

equilibrium price but it’s supply has failed to meet demand and consequently put pressure on it

from those waiting for the product as well as observers of the industry therefore it can’t reach it

at it’s current state. Tesla has also shown that their company’s demand curve is affected by some

of the five variables that Krugman and Wells say will shift it. For instance, a “change in
 Tesla and Principles of Microeconomics 4

expectations” (Krugman and Wells, pg. 98) because people expect that their product will

eventually be made, and “a change in the number of consumers” (Krugman and Wells, pg. 98).

Tesla has additionally shown that their company’s supply curve is affected by some of the five

variables that Krugman and Wells say will shift it. The ones that are apparent are first, “a change

in technology” (pg. 98), they’re producing their products by hand instead of making it automated

which slows down production. Secondly, “a change in expectations” (pg. 98), which is causing

them to produce less than what they think they can in the window they give themselves. This is

how Tesla as a company can relate to the concepts of supply and demand.

Now we will examine which major type of market Tesla is a part of. Tesla is a part of the

automotive industry. Therefore, we must look into what characteristics the automotive industry

has that could define it as one of the four major types of market. The four major types of

markets according to Krugman and Wells (2015) book, Principles of Economics 4th edition are

perfect competition, monopoly, oligopoly, and monopolistic competition (Krugman & Wells,

2015 p. 358, 415, 441, 462). To be able to understand and differentiate these four markets we

will define what they are based off of Krugman and Wells book, Principles of Economics 4th

edition. First, Krugman and Wells define a perfectly competitive industry as “an industry in

which producers are price-takers.” (Krugman and Wells, 358) and they define a price-taking

producer as, “a producer whose actions have no effect on the market price of the good or service

it sells.” (Krugman and Wells, 358). Second, Krugman and Wells define a Monopoly as “an

industry controlled by a monopolist” (Krugman & Wells, p. 387) and a monopolist is the sole

“producer of a good that has no close substitutes” (Krugman & Wells, p. 387). Third Krugman

and Wells define an Oligopoly as a market where “there are only a few sellers” (Krugman &

Wells, p. 441). And finally, Krugman and Wells define monopolistic competition as “a market in
 Tesla and Principles of Microeconomics 5

which there are many competing producers, each producing a differentiated product, and there is

free entry and exit in the long run” (Krugman & and Wells, 2015, p. 462).

Again, Tesla belongs to the automotive industry and now we’ll go into how the

automotive industry is an oligopoly. An oligopoly is a market where “there are only a few

sellers” (Krugman & Well, 2015, p.441). One of the biggest indicators that this is the case for the

automotive industry is how close the top four companies are in units sold. The top four vehicle

manufactures sold a total of 41.2 million units, Volkswagen Group sold 10.74 million, Relnaut-

Nissan-Mitsubishi sold 10.61 million units, Toyota sold 10.47 million units sold, and GM sold

9.6 million units (Zhang, Nudelman, Gould, 2015). Another huge indicator that this industry is

an oligopoly is that out of the top 14 automotive companies the top 4 own 23 of the total 55

brands (Zhang, Nudelman, Gould, 2015). That’s 41.8% of the automotive industry. Seeing that

four companies own this much of the market and sell a similar number of units displays that this

is an oligopoly. And to make it more relatable to Tesla they are only a leader in a niche of this

market (electric vehicles) and therefore don’t have much market share in the industry as a whole

and aren’t apart of the oligopoly. To provide clarity, Margret Rouse a writer and manager for

WhatIs.com, a website that has won many awards and has been cited as an authority in major

publications such as the New York Times defines market share as “the percentage of sales in a

market acquired by a particular company.” (Rouse, 2017). According to Statista, a portal with

statistics and studies from more than 22,500 Sources, in 2017 the automotive industry sold 79.02

million units (Statista, 2018), while in 2017 Tesla sold 80,060 cars (Banderiz, 2018, pg. 49). That

means Tesla’s market share is 0.001% of the automotive industry. Yet in Tesla’s niche (electric

vehicles) they have more market share. According to the website EVobession there were 14,462

electric vehicles sold in February of 2018 and of those Tesla sold 6,960 of them (EVobsession,
 Tesla and Principles of Microeconomics 6

2018). This means that Tesla has a market share of 48.1% in the electric vehicle niche of the

automotive industry. What does this mean? Tesla overall is a minnow in a pond filled with blue

whales.

Next, we will calculate and apply the various production costs in relation to Tesla. To do

this, we need to define the various production costs. Mike Mofatt, a writer for ThoughtCo. has

studied economics at four different universities in three countries and has taught economics at

both the university and community college level. And he will define marginal cost, total cost,

fixed cost, total variable cost, average total cost, average fixed cost, and average variable cost

before we relate them to Tesla. Marginal cost is defined as “the cost a company incurs when

producing one more good” (Mofatt, 2017). Total cost is defined as “all the costs incurred in

producing a certain number of goods” (Mofatt, 2017). Fixed cost is defined as “the costs that are

independent of the number of goods produced, or more simply, the costs incurred when no goods

are produced.” (Mofatt, 2017). Total variable cost is defined as “the costs that do change when

more is produced.” (Mofatt, 2017). Average total cost is defined as “the total cost over the

number of units produced” (Mofatt, 2017). Average fixed cost is defined as “fixed costs over the

number of units produced” (Mofatt, 2017). And the average variable cost is defined as the total

variable costs over number of units (Mofatt, 2017).

To relate costs listed above to Tesla we will discuss the numbers within Tesla’s 2017 10-

K annual report written by Eric Branderiz and for the numbers we cannot find we’ll create

hypothetical ones. First, we will calculate the marginal cost. To do this, we’ll subtract the total

cost of producing 80,060 (Banderiz, 2018, pg. 49) cars in comparison to the total cost of

producing 50,000 cars. It costs $9,536,264,000 (Banderiz, 2018, pg. 51) to produce the 80,060

cars (Banderiz, 2018, pg. 49) and $ 5,955,698,000 produce 50,000 cars. The difference between
 Tesla and Principles of Microeconomics 7

the two costs is $ 3,580,566,000, hence the marginal cost is $3,580,566,000. Second, we’ll find

the Total cost. The total cost is found by adding all the costs incurred when producing a certain

number of goods. When Tesla produced 80,060 cars in 2017 (Banderiz, 2018, pg. 49) Eric

Banderiz (2018) wrote that Tesla had a total automotive cost of revenues being $7,432,704,000,

Services and other costs of $1,229,022,000 and energy generation and storage segment cost of

$874,538 (Banderiz, 2018 pg. 51). That makes the total cost of revenues $9,536,264,000 for

80,060 cars. The average total cost would then be the total cost divided by the number of

vehicles making it $119,114. The total variable cost would be calculated by finding out the costs

that do change when more is produced. So, the cost for energy generation and storage segment is

$874,538,000 (Banderiz, 2018 pg. 51) which would be considered a variable cost. Now to find

average variable cost we would divide this by the number of cars delivered 80,060 (Banderiz,

2018, 49), making the average variable cost $10,924. Total fixed cost I cannot calculate based

off the data given in the 10k annual report because they do not discuss it, however an example of

a fixed cost can be found. We’ll suppose the only cost that the only costs that occur when

nothing has been produced are the cost of the plant. And we’ll make an estimate that the plant

cost tesla $20,000,000 so the total variable cost would be $20,000,000 and the average would be

that number divided by the total cars delivered in 2017 that number again being 80,060

(Banderiz, 2018, 49) making the average total variable cost $249.81.

Fourth and Finally, we’re going to relate concepts of price, income, and cross-price

elasticities to Tesla. First, we will define these terms. To begin, price elasticity of demand is

defined in Krugman and Wells book, Principle of Economics 4th edition as “the ratio of percent

change in the quantity demanded to the percent change in the price as we move along the

demand curve” (Krugman & Wells, 2015, pg. 162). Secondly, cross price elasticity of demand is
 Tesla and Principles of Microeconomics 8

defined in Krugman and Wells book, Principle of Economics 4th edition as “the ratio of the

percent change in the quantity demanded of one good to the percent change in the price of the

other.” (Krugman & Wells, 2015, pg. 174). Finally, income elasticity of demand is defined in

Krugman and Wells book, Principle of Economics 4th edition as “the percent change in the

quantity of a good demanded when a consumer’s income changes divided by the percent change

in the consumers income.” (Krugman & Wells, 2015, pg. 175). Price elasticity of Tesla’s model

3 would change if it’s current quantity demanded is 400,000 and the current price is $35,000 to

being priced at $20,000 and having a demanded quantity of 500,000. The change in quantity

demanded would be ((500,000 – 400,000) / 400,000) equaling 25% demand increase. Cross-price

elasticity of demand between the Tesla model 3 and the Chevy bolt change based off the price of

the other. If the Chevy bolts price raises by 30% and therefore the Tesla model 3 demand goes

up by 35% then the cross-price elasticity of demand is 1.167 (0.35/0.30). Income elasticity of

demand when related to Tesla could be looked at as if everyone in the U.S. obtained an

additional 25% in their income and the result of that increased the demand of the Tesla Model 3

by 40%. This would make the income elasticity of demand 1.6 (0.40/0.25).

All in all, when looking at Tesla you can compare it to major topics throughout Paul

Krugman and Robin Wells Principles of Economics 4th edition. You can use Tesla to help make

real world comparison to the concepts surrounding supply and demand. You can use the

automotive industry that Tesla is apart of to help compare and understand the four major types of

markets. You can use it’s 10k annual statement to discuss various production functions. And

finally, you can use Tesla to apply concepts of price, income and cross- price elasticities. Now

you must ask yourself, is there anything Tesla can’t do?

 Tesla and Principles of Microeconomics 9

Works Cited

Kolodny, L. (2018, January 25). Tesla employees say to expect more Model 3 delays, citing

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than-known.html

Peavler, R. (2017, February 1). A Guide to Fixed and Variable Costs of Doing Business.

Retrieved from https://www.thebalance.com/a-guide-to-fixed-and-variable-costs-of-

doing-business-393479

Margaret, R. (2017). Market Share. Retrieved from

http://whatis.techtarget.com/definition/market-share

Statista. (2018). Number of Cars sold worldwise from 1990 to 2018 (in million units). Retrieved

from https://www.statista.com/statistics/200002/international-car-sales-since-1990/

Statista (2018). Number of Tesla vehicles delivered worldwide from 2nd quarter 2015 to 4th

quarter. Retrieved from https://www.statista.com/statistics/502208/tesla-quarterly-

vehicle-deliveries/

EVObsession (2018). Electric Car Sales (Monthly Reports). Retrieved from

https://evobsession.com/electric-car-sales/

Moffat, M (2017, October 7). How to Calculate the 7 Cost Measures. Retrieved from
 Tesla and Principles of Microeconomics 10

https://www.thoughtco.com/understand-and-calculate-cost-measures-1146327

Banderiz, E. (2018, February 22). United States Securities and Exchange Commission

Washington, D.C. 20549 Form 10-K. Retrieved from

http://ir.tesla.com/secfiling.cfm?filingID=1564590-18-2956&CIK=1318605