CASE STUDY ANALYSIS A-CHAPTER 5 (by Yagmur Pekoz)

Question 1: Explain fully how auto manufacturers should choose among substitutable inputs and production processes. Discuss in detail and apply the related concepts.
Answer 1: Both the demand and the unit price for steel have increased in recent years. Unfortunately, auto manufacturers use large quantity of steel in their production process. In order to compensate for the adverse effect of increased unit price of steel, auto manufacturers changed their output and pricing decisions to be profitable. Moreover, they started searching new overseas suppliers and cheaper raw materials, e.g. aluminum, to substitute steel in the production process. In addition, auto manufacturers intensified their search on new means and methods to utilize plastics, magnesium, and recyclable materials in their production process. All these new ideas aimed to make auto manufacturers more profitable. Generally, we can substitute one input with another, however, the case is not always as easier as it seems.
As mentioned before, firms usually substitute one or more inputs with another to be profitable. The above idea of substitution can be demonstrated simply as Q = (S) ½ x A½ where S is steel and A is aluminum. This equation is called ‘production function’. According to this equation, for example, the same amount of auto parts (let us say 100 for the sake of argument) can be produced using either 100 pounds of steel (S=100) and 100 pounds of aluminum (A=100), or 25 pounds of steel (S=25) and 400 pounds of aluminum (A=400).
Unfortunately, there are some factors that restrict the validity of the substitution discussed, for example, fixed proportions. If we assume that 100 pounds of aluminum and 100 pounds of steel need to be used to produce 100 auto parts, this implies that, in order to produce 200 auto parts, we will need 200 pounds of