In response to the drastic reduction in global travel that began in March 2020, rental car companies were forced to reduce costs in order to remain in business. One major cost-reduction maneuver was reducing their fleet size, i.e. selling their cars. This move allowed them to reduce storage and maintenance costs in the short-run, as well as generate some cash reserves to pay their fixed costs, with the expectation that they could rebuild their fleets when business returned to pre-pandemic levels.
As more and more people have begun to travel over the past few months, however, rental car companies have found it is not quite so easy to rebuild their fleets. One of the primary reasons has been a shortage of semiconductors in the automobile industry. Increased demand for consumer electronics, such as gaming consoles, laptop computers, and televisions coupled with supply chain disruptions, reduced the availability when auto manufacturers were ready to restart production. As a result, auto manufacturers have had to limit production and prioritize which models to build, giving preference to their most popular, and most profitable, models. General Motors, for example, halted production of the Chevrolet Camaro in order to produce more Silverado pick-up trucks. This has left car rental companies unable to buy the type and quantity of cars necessary to rebuild their fleets to a size necessary to satisfy the rising demand.
The result of this combination of rising demand and reduced supply is, unsurprisingly, a dramatic increase in rental car prices. In some places, cars that would normally rent for $15-20 per day are now renting for up to $750 per day. Some consumers, however, have found creative solutions. Tourists in Hawaii have been reported to be seen driving U-Haul trucks to the beach. Rather than pay hundreds of dollars for a rental car, tourists have been taking advantage of U-Hauls $19.95 (plus $0.89 per mile) daily rental price for pick-up trucks and cargo vans. For their part, since U-Haul does not consider themselves a rental car operation, they have no plans to change their marketing and pricing as a result of this phenomenon. However, they are encouraging would-be movers to make reservations far in advance, and are steering them toward larger trucks.
Discussion/Questions:
- Use a supply and demand model to show the following:
- The change in equilibrium price and quantity after global demand for rental cars decreased
- The subsequent decrease in supply after rental car companies reduced the size of their fleets. What can you say about the new equilibrium after both demand and supply decreased?
- The change in equilibrium price and quantity after demand increased, but supply remained the same. How does this compare to the original equilibrium price and quantity before the global travel slowdown?
- Given Hawaii’s geographic location, how do you think rental car companies’ price elasticity of supply compares to that of car companies on the US mainland? Explain.
- U-Haul famously has their rental rates painted on the side and back of their vehicles. If they are unable to change their prices after demand increases, does this advertised price act as a price ceiling or a price floor? Will this create a shortage or a surplus?
Sources: The New York Times: Used Cars from Shrinking Rental Fleets May Not Be the Steal You Expect. CNBC: How a chip shortage is battering the automotive industry. The New York Times: A Tiny Part’s Big Ripple: Global Chip Shortage Hobbles the Auto Industry. The Washington Post: Tourists in Hawaii are driving U-Hauls because rental cars are so expensive. Photo: By WestportWiki – Own work, CC BY-SA 3.0, https://commons.wikimedia.org/w/index.php?curid=24830701.