South-Western EconNews

Steeling For Recession and Competition

Subject

Short Run and Long Run Costs

Topic

Production and Costs

Key Words

Consolidation, Over-Capacity, Cyclical, Inventories, Recessions, Unions, Governmental Pressure, Job Reductions, Plant Closures, Productivity Levels, Debts, Losses, Global Market

News Story

Three European steel companies based in France, Luxembourg, and Spain have agreed to merge to form the world's largest steel company, called NewCo for the time being. Investors hope that more consolidation will occur, reducing fragmentation and over-capacity. The industry is highly cyclical and is slow to reduce inventories in recessions. Unions and governmental pressure slow efforts to reduce costs.

It is unclear how successful NewCo will be. Although it talks of job reductions and plant closures, it has ruled out traumatic cuts, but it is being opposed by its Belgian unions. The company will still only have 6 percent of the global market.

In spite of their problems, European producers are ahead of American steel makers that are smaller and have productivity levels that are 40 percent lower, resulting in huge debts and losses.

(Updated April 1, 2001)

Questions

1.	a) Draw a diagram of a steel company's short run average total and marginal cost curves, and add an initial price line, such that the company is making a small profit. What happens to the price line in a recession? Why? b) Why is it important to reduce steel inventories in downturns? Refer to your diagram.
2.	a) Draw a diagram of the long run average cost curve for a steel company. Add the short run average and marginal cost curves for a typical European steel producer. Show how a merger between three companies can affect the position of the short run curves. b) Why is the merger potentially beneficial to the producers? c) What is needed to produce these benefits? Why is there skepticism that the benefits can be gained?
3.	a) The US producers are reported to be smaller, unproductive, and making losses. Explain what this implies about their short run cost curves, their position on their long run average cost curves, and the price of the steel they produce. b) What would you recommend that they do? Why?

Source

Carlta Vitzthum, "Mergers May Not Gird Steel Sector," The Wall Street Journal Europe, February 26, 2001.