Sales of hybrid cars continue to grow — even our neighbors bought one. But the increasing popularity of hybrids doesn’t necessarily mean that the costs of making batteries for them will get cheaper. In fact, it could result in what economists call ‘an increasing cost industry.’ This is an uncommon situation.
More often, changes in per-unit average cost come as a result of a larger or smaller production plant. If average costs fall as a factory gets bigger, economists say there are “economies of scale.”
The opposite situation where unit costs rise as a factory or company get bigger is “diseconomies of scale.” These were common in Soviet industry when the Kremlin made a fetish of having the world’s largest steel mill, truck factory or whatever. And, considering the companies as a whole, GM and IBM in the 1970s both probably were examples of diseconomies of scale.
The idea of an increasing or decreasing cost industry is different. Here the question is what happens to prices as an entire industry, perhaps comprising many companies, gets larger or smaller.
Decreasing cost industries are common for a new technology or product. From 1900 to about 1935, automobile manufacturing was a decreasing cost industry — costs per car fell as total national car production rose. The same has been true for computers over the past 30 years.
Decreasing costs for an entire industry may stem from improved technology such as disk drives with fewer moving parts or ground crankshaft journals. It may be due to “learning by doing” in manufacturing processes themselves. It may be due to economies of scale in factories that produce specific components like disk drives, radiators, engine blocks or flat-screen monitors.
Increasing cost industries are much less common. Here the driving force often is that as output grows, the industry bids up the price of a key input. When the first ethanol plants were built, their consumption of corn was so small that it did not affect national corn prices. But as total output of ethanol grew, that changed. Now a growing industry is driving up the price of the feedstock. Unless technology that permits using a new input like biomass is perfected, the increasing cost of corn will limit the growth of overall ethanol production.
The need for some key raw material, the output of which is difficult to ramp up, has provoked increasing cost in other industries. During the battleship arms race prior to World War I, the inability to rapidly increase production of nickel, a key ingredient in steel alloys, drove up the average cost of the thousands of tons of armor plate in each vessel.
Similar bottlenecks with chromium drove up the price of stainless steel manufacturing as it moved from a highly specialized product made in small quantities to one with many high-volume applications. Platinum did the same for catalytic converters. The precious metal had been used as a catalyst in industrial processes for decades, but never in the quantities needed for 20 million or more automotive catalytic converters per year.
Lithium may pose similar challenges for electric car batteries. The element has had industrial uses for years in everything from pharmaceuticals to lubricating greases to torpedo motors. But none of these applications use more than a fraction of what would be needed if electric cars using lithium-ion batteries reached a significant share of total output.
There are alternatives. Most early hybrids used nickel-metal-hydride batteries. But lithium-based batteries have many advantages, including less weight. The Chevy Volt has this type of battery and other manufacturers are following.
If electric or hybrid cars remain a novelty, there won’t be a problem. But if their popularity grows, where the lithium will come from becomes a question. The element is plentiful in several forms, but not easy to separate. Brine from alkali salt lakes in the Andes of Chile, Argentina and Bolivia is the best source, but building the plants to extract and purify lithium takes time.
Companies are hesitant to make huge investments before knowing just what the demand will be. So if sales of these cars take off, lithium prices may rise rapidly and stay up for some years as production of the crucial raw material catches up with demand for the final product. This is a classic example of an increasing cost industry.
In the future, lithium recycled from used batteries will be available, just as scrap steel from junked cars now nearly matches tonnages of new steel going into cars. With a stable national fleet of electric cars, demand for virgin lithium thus will be lower than when the fleet is still growing. In the meantime, it will make a nice example for econ profs to cite.
© 2010 Edward Lotterman
Chanarambie Consulting, Inc.