001433-0003 Bishop 1 Dakota Bishop IB Extended Essay – Economics Advised by Fred Jenkins IB Candidate Number 001433-0003 2/2/2015 Research question: How has the appreciation of the Japanese yen relative to the United States dollar from 2012 to 2013 affected the sales of Honda and Toyota brand automobiles in the US during this time? Word Count: 3749
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001433-0003 Bishop 1
Dakota Bishop
IB Extended Essay – Economics
Advised by Fred Jenkins
IB Candidate Number 001433-0003
2/2/2015
Research question:
How has the appreciation of the Japanese yen relative to the United States dollar from 2012 to
2013 affected the sales of Honda and Toyota brand automobiles in the US during this time?
Word Count: 3749
001433-0003 Bishop 2
Abstract
Research Question
In any international market, the exchange rate between the currency of the producing country
and the currency of the consuming country has a major impact on the sales of any given good. In
recent years, Japan’s yen has been appreciating relative to the US dollar, which translates into
relatively higher costs for firms that operate in yen. This research seeks to answer the question:
How has the appreciation of the Japanese yen relative to the United States dollar from 2012 to
2013 affected the sales of Honda and Toyota brand automobiles in the US during this time?
Process of Investigation
Much of the investigation of this topic was conducted through data of historical exchange rates,
coupled with figures for Honda and Toyota’s automobile sales, from their respective company
profiles, through 2012 and 2013. Various online articles and databases were also consulted to
support and explain data trends that went against predictions based on economic theory.
Conclusion
Despite predictions of a reduction in sales of Honda and Toyota made automobiles in the US
with the appreciation of the Japanese yen, data shows that both firms experienced an increase in
both total revenue and profit from the beginning of their 2012 fiscal year to the end of their 2013
fiscal year. This unexpected growth can be attributed to a combination of consumer loyalty,
economies of scale, technological improvements to the goods, and the growing US automobile
market.
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Table of Contents
Title Page ………………………………………………………….…………………………1
Abstract ……………………………………………………………………………………....2
Table of Contents…………………………………………………………………………….3
I. Introduction ……………………………………………………………………….….…...4
II. Theory………………………………………………………………….………………....4-8
A. Exchange Rates……………………………………………………….…………..4-6
B. Appreciation and Exporting Firms……………………………………….……….6-7
C. Price Elasticity of Demand……………………………………………………....7-8
III. Data……………………………………………………………………………………..8-10
A. Exchange Rate between the US Dollar and the Japanese Yen…………………..8-9
B. Revenue and Income……………………………………………………………..9-10
IV. Trend Analysis…………………………………………………………………………..10-16
A. Consumer Loyalty……………………………………………………………......11
B. Elasticity Revisited……………………………………………………………….12-13
C. Economies of Scale………………………………………………………………13-14
D. Technological Improvements………………………………………………….....14-15
E. The US Automobile Market…………………………………………………..….15-16
V. Conclusion……………………………………………………………………………….16-18
VI. Works Cited…………………………………………………………………………….19
VII. Appendices …………………………………………………………………………….20-21
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I. Introduction
*all references to the “dollar” refer to the United States dollar*
Recently, the U.S. dollar has been losing value relative to the Japanese yen as explained
by a complex combination of economic factors. This changing value of currency has an impact
on the prices of goods exchanged between Japan and the U.S., and therefore affects total revenue
earned by firms in the respective foreign market – that is, the U.S. market for Japanese goods
and the Japanese market for U.S. goods. Specifically, the U.S. market for two Japanese car
brands, Honda and Toyota, between the beginning of their 2012 fiscal year and the end of their
2013 fiscal year, will be analyzed with respect to the changes in sales of these cars stemming
from the yen’s appreciation relative to the U.S. dollar
.
II. Theory
A. Exchange Rates
In order to understand the effects of fluctuating exchange rates, we must first understand
how they work and what causes the fluctuation. An exchange rate by definition is the value of
one currency relative to another – essentially, it is the price of one unit of foreign currency in
terms of another. These rates are determined in foreign exchange markets governed by the laws
of supply and demand.
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As visible
in the graph above, the rate of exchange for yen and U.S. dollars is determined by the
intersection of supply (S) - which derives from domestic (in this case, Japanese) demand for
foreign goods, services, and investment – and demand (D) – which derives from foreign demand
for domestic goods. In this model, either curve can shift due to changes in relative GDP growth
rate, interest rate, or price level, or shifts in tastes or speculations. For example, if more U.S.
citizens decide to travel to Japan, the demand curve for yen will shift rightward as shown above,
increasing the equilibrium dollar per yen rate from P to P1 and thus causing appreciation of the
yen.
Dramatic variations in exchange rates have a significant impact on a nation’s economy,
influencing domestic GDP and inflation, unemployment rate, and trade deficit. For this reason, it
is uncommon for a country to let its exchange rate float freely – that is, to let it be determined
solely by the market. Today, the most common mode of handling exchange rate – and therefore
controlling the economic factors it affects – is the managed exchange rate, used by Japan. With
this strategy, a country will allow its rate to float, but intervenes to change either supply or
demand if it deviates too dramatically. It is important to note that the United States is one of the
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few countries to use “floating” exchange rates today, meaning that the U.S. government very
rarely intervenes in the economy with the intent to influence USD exchange rate1.
B. Appreciation and Exporting Firms
The currently rising dollar per yen rate, also termed as the appreciation of the yen, lends
many advantages to the Japanese economy that might prompt Japan to facilitate it through their
exchange rate managing policies. A stronger currency allows for relatively cheaper imports,
which benefits consumers’ standard of living as well as firms that rely on imported factors of
production. Japan would also be able to easier alleviate a large foreign debt, specifically to the
U.S., if the yen grew in value relative to the dollar. However, according to economic theory,
appreciation is not beneficial to exporting firms. As the yen appreciates relative to the dollar,
prices of Japanese products and services rise compared to those from the U.S. with all other
factors remaining equal, since it now takes more dollars to equal one yen. Applying this model to
the U.S. market for automobiles, the price of Japanese made imported automobiles will rise
relative to the price of domestically produced automobiles, all other factors remaining equal.
Since Japan is a relatively small, highly importing nation, it makes sense that the
Japanese government would manage exchange rates to keep the yen at a high value to keep
prices low on the many important goods that they must import (i.e. agricultural products or
natural resources). As discussed in the previous paragraph, though, exporting firms would be
expected to sell less due to increased costs. However, to determine whether this will result in a
1 Stone, Mark, Harald Anderson, and Romain Veyrune. "Finance and Development." Finance & Development, March 2008. International Monetary Fund, 13 Mar. 2008. Web. 27 Jan. 2015. <http://www.imf.org/external/pubs/ft/fandd/2008/03/basics.htm>.
001433-0003 Bishop 7
decrease in total revenue, price elasticity of demand of the exported automobiles must be
examined.
C. Price Elasticity of Demand (referred to from now on as “elasticity”)
According to the law of demand, as a product’s price increases, a lower quantity of it is
demanded by consumers. Generally, this lower quantity demanded is expected to hurt a firm
producing the good whose price has risen – in this case, Japanese made automobiles sold in the
United States of America. However, one more factor must be analyzed in order to make this
judgment: the product’s elasticity. Elasticity refers to the percentage change in quantity
demanded of a good as compared to the percentage change in its price. For an elastic good, the
percentage change in quantity demanded is always greater than the percentage change in price. A
product’s elasticity hinges on many factors, including price relative to income, necessity, and
availability of substitute or complementary goods.
The concept of elasticity can be demonstrated with a simple example. A ten percent price
increase in bottled water, from $1.00 to $1.10, would logically lead to a very small reduction in
how many are sold; bottled water is not very expensive and, while there are many substitutes,
water is a necessity. On the other hand, a ten percent increase in the price of a $300,000 house
represents an additional $30,000 the consumer must spend. In this example, bottled water is
relatively inelastic while a new house is extremely elastic. Because new cars are expensive
relative to consumers’ income, are not strictly necessary, and have many substitutes, they are
considered an elastic good. That is to say, a small price increase on a new car would lead to a
large decrease in sales as customers either decide to buy a used car, a less expensive or other
substitute car, or another mode of transportation.
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Examining the economic ramifications of the high elasticity of new automobiles
corroborates the expected decrease in total revenue of Honda and Toyota as their prices increase
due to the yen’s appreciation. The total revenue of a firm is equal to the price of its product
multiplied by the number of products sold. For an elastic good, the decrease in quantity
demanded (synonymous with quantity sold) outweighs the increase in price, meaning that total
revenue should fall.
III. Data
A. Exchange Rate between the US Dollar and the Japanese Yen2
As of April 1st, 2012 (the beginning of the fiscal year for both Honda and Toyota), the
average bid exchange rate between dollars and yen was 82.30 dollars (USD) per yen (JPY). The
yen’s relative value fell to a short-term low of 77.85 dollars per yen in late September of 2012;
however, since that week, the yen has had a strong upward trend of appreciation, ending in
March 2013 at a rate of 94.32 dollars per yen, as shown below.
As illustrated, the yen has had a remarkable growth against the dollar in the examined
time period – over 12.7% appreciation in just two years. Since it now takes 12.7% more dollars
to buy an item with an otherwise unchanged price in yen, it is expected that less Japanese cars
will be sold in the U.S. in 2013 compared to 2012 due to the law of demand – that is, quantity
sold will decrease as price of these automobiles increases due to the appreciation of the yen. This
trend has a potential to devastate Japan’s exporting firms; “Numerous executives from almost all
of the Japanese automakers have stated that recent yen/dollar exchange rates have made
automotive manufacturing unsustainable in Japan”1. However, Honda and Toyota are far from
powerless in fighting this negative market condition.
B. Revenue and Income
HONDA MOTOR CO.3 2012 2013 Percent Change (2012-2013)
Total Revenue 7,948,095 9,877,947 +19.50%
Net Income 211,482 367,149 +42.40%
TOYOTA MOTOR CO.4 2012 2013 Percent Change (2012-2013)
Total Revenue 18,583,653 22,064,192 +18.70%
Net Income 355,627 1,320,888 +271.40%
3 "Honda Motor Co., Ltd. Company Profile." Datamonitor: 1-11. Datamonitor. Web. 2 June 2014. See Appendix 1.
4 "Toyota Motor Corporation Company Profile." Datamonitor: 1-11. Datamonitor. Web. 2 June 2014. See Appendix 2.
*Year refers to the total fiscal year (ends March 31 of given year), and all revenue and income figures are in millions of yen.*
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Both Honda and Toyota have experienced a large growth in total revenue and an even
more significant increase in net income from 2012 to 2013, despite the anticipated effects of the
appreciation of the yen. Yet there is further evidence against the expected trend – both firms’
year-end financial reports articulate a growth in sales specifically from North America, where a
significant portion of the market comes from the United States. Though the yen’s appreciation
increases relative price of production Japan, “Honda’s consolidated unit sales [of automobiles] in
North America increased 30.8% from the previous fiscal year”5 while Toyota’s sales similarly
rose 32.3% in the same region according to their 2013 report6.
IV. Trend Analysis
Clearly, the trend of growth in total revenue as well as income defies the expected decline
due to the appreciation of the Japanese yen. Even Honda Motor Co. acknowledges that their
“results of operations would be adversely affected by an appreciation of the Japanese yen against
other currencies, in particular the U.S. dollar.”4 Why then do we see such a growth when we
would expect the opposite? Therein lies the beauty of economics – it takes a complex interaction
of countless factors to reach a real-world result. These factors all have a different magnitude of
impact on the ultimate growth in sales of Honda and Toyota, yet all play an important role in the
final result. It is important to note that the average price of these automobiles sold in the U.S.
fluctuates beyond the effects of the firms’ costs, and therefore cannot be deemed directly related
to the appreciation of the yen. For example, a change in tastes toward higher-end cars would
5 "Honda Motor Co., Ltd. Company Profile." Marketline: 1-10. Marketline. Web. 2 June 2014.
6 "Toyota Motor Corporation Company Profile." Marketline: 1-11. Marketline. Web. 2 June 2014.
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drive up the average price of all Honda brand automobiles sold, though it does not relate to the
goal of this research. For this reason, possible explanations for the data trends will be discussed
without actual data of prices of Honda and Toyota automobiles.
A. Consumer Loyalty
Consumer loyalty refers to the perceived additional value of a good or service based on a
positive emotional experience associated with it. Both Honda and Toyota automobiles are widely
recognized as very reliable, practical, and economical cars by consumers and professionals alike.
This strong brand name gives both firms a very desirable market position, resulting in a
“significant competitive advantage … [in] international markets”7 In addition, both companies
have a loyalty rewards program, where dedicated consumers are rewarded with incentives like
lower interest rates on payments, discounts on maintenance, and other complimentary services
for continuing to buy the firm’s automobiles. The combination of the loyalty programs and a
general consumer approval of both firms, especially in the U.S., results in a very high level of
consumer loyalty regarding both Honda and Toyota automobiles, despite their high elasticity
primarily due to price (see “Elasticity Revisited” below). Taking this into account, it is very
probable that consumers would not mind a small increase in price coming from a likable,
reliable, consumer-friendly company that they have been buying from for many years.
Additionally, if consumers are willing to buy these cars as price increases, this would put upward
pressure on Honda and Toyota’s total revenue figures, though it would not reflect a true increase
in sales.
7 Honda Motor Co., Ltd. Company Profile
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While consumer loyalty is a likely contributing factor to a lack of falling sales of Honda
and Toyota automobiles in the U.S. despite the yen’s appreciation, it does not play a significant
role in the growth in sales that is actually present.
B. Elasticity Revisited
It has been established that Honda and Toyota are considered to make very reliable, safe
cars that have a high perceived value relative to price. Besides the aspect of consumer loyalty,
the general positive attitude toward these firms also contributes to their unexpected growth in
sales through elasticity. As discussed in the theory of elasticity section, automobiles are a prime
example of an elastic good due to a high price relative to income, a wide availability of
substitutes (other new cars), and a low perceived necessity (compared to food or shelter, for
example). The automobiles produced by Honda and Toyota may actually be less elastic than
others, however, when examined in the U.S. market. The World Bank reported 786 automobiles
per 1,000 people in the U.S. in 2011, one of the highest in the world.8 This supports the claim
that – at least in developed countries like the United States – automobiles have become more of a
necessity than a luxury, with an average of more than one car for every family in the United
States. And while there still exists a huge selection of substitute automobiles, there are few cars
that can rival Honda and Toyota in reliability, which is a huge factor in choosing a car as a
necessity. In fact, the top 3 most reliable car brands of 2013 according to Consumer Reports
were Acura, a brand name of Honda Motor Corporation, and Lexus and Toyota, both brand
names of Toyota Motor Corporation.9 All automobiles of course are still large purchases relative
8 Passenger Cars (per 1,000 People). Rep. N.p.: World Bank, 2014. The World Bank Data. Web. 14 Nov. 2014. <http://data.worldbank.org/indicator/IS.VEH.PCAR.P3>.
"Honda Motor Co., Ltd. Company Profile." Datamonitor: 1-11. Datamonitor. Web. 2 June 2014.
"Honda Motor Co., Ltd. Company Profile." Marketline: 1-10. Marketline. Web. 2 June 2014.
Passenger Cars (per 1,000 People). Rep. N.p.: World Bank, 2014. The World Bank Data. Web. 14 Nov. 2014. <http://data.worldbank.org/indicator/IS.VEH.PCAR.P3>.
"Toyota Motor Corporation Company Profile." Datamonitor: 1-11. Datamonitor. Web. 2 June 2014.
"Toyota Motor Corporation Company Profile." Marketline: 1-11. Marketline. Web. 2 June 2014.
McAlinden, Sean P., Ph.D., and Yen Chen. "Center for Automotive Research." The Effects a U.S. Free Trade Agreement with Japan Would Have on the U.S. Automotive Industry (2012): 8-10. CarGroup. Center for Automotive Research, 21 Aug. 2012. Web. 14 Oct. 2014. <http://www.cargroup.org/assets/files/the_effects_a_u.s._free_trade_agreement_with_japan_would_have_on_the_u.s._automotive_industry2.pdf>.
Stone, Mark, Harald Anderson, and Romain Veyrune. "Finance and Development." Finance & Development, March 2008. International Monetary Fund, 13 Mar. 2008. Web. 27 Jan. 2015. <http://www.imf.org/external/pubs/ft/fandd/2008/03/basics.htm>.
Szakaly, Steven, ed. "Annual Financial Profile of America's Franchised New-Car Dealerships." NADA Data 2014 (2014): 5-9. NADA.org. National Automobile Dealer's Association, 28 May 2014. Web. 7 Jan. 2015. <http://www.nada.org/NR/rdonlyres/DF6547D8-C037-4D2E-BD77-A730EBC830EB/0/NADA_Data_2014_05282014.pdf>.
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Appendices
Appendix 1 – Figures for Honda Motor Co., Ltd.
Appendix 2 – Figures for Toyota Motor Co., Ltd.
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Appendix 3 - New-vehicle sales and market share, by manufacturer in US