Transportation Economics I

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Transportation Economics2101337 Transportation Engineering

Saksith Chalermpong, Ph.D.

2101337 Transportation Engineering -Transportation Economics

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Outline

• Transportation Economics Part 1: Microeconomics– The economic perspective

– Demand, supply, and market equilibrium

• Transportation Economics Part 2: Market Failures & Transportation Economics– Market failures

– Elasticity– Characteristics of transport demand and supply

– Benefit of transport supply increase

– Market failures in transport and the roles of government


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Transportation Economics Part 2Market Failures &

Transportation Economics


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Market failures

• Public goods

• Externalities

• Government’s roles in the economy


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Private Goods Characteristics

• Rivalry (in consumption) means that when one person buys and consumes a product, it is not available for another person to buy and consume. – When Adams purchases and drinks a bottle of mineral

water, it is not available for Benson to purchase and consume.

• Excludability means that sellers can keep people who do not pay for a product from obtaining its benefits. – Only people who are willing and able to pay the

market price for bottles of water can obtain these drinks and the benefits they confer.


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Public Goods Characteristics

• Nonrivalry (in consumption) means that one person’s consumption of a good does not preclude consumption of the good by others. – Everyone can simultaneously obtain the benefit from a

public good such as national defense, street lighting, a global positioning system, or environmental protection.

• Nonexcludability means there is no effective way of excluding individuals from the benefit of the good once it comes into existence. – Once in place, you cannot exclude someone from

benefiting from national defense, street lighting, a global positioning system, or environmental protection.


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Free-Rider Problem

• The two characteristics of public goods, nonrivalry and nonexcludability, create a free-rider problem.

• Once a producer has provided a public good, everyone, including nonpayers, can obtain the benefit.

https://storylog.co/story/56b82c45a44857910b438fc62101337 Transportation Engineering -Transportation Economics

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Implications of Free-Rider Problem on Public Goods Supply• Most people do not pay for something that they can

obtain for free ➔ they become free riders. • These free riders like the public good and would be

willing to pay for it if producers could force them to pay– but nonexcludability➔ no way for producers to withhold

the good from the free riders without also denying it to the few who do pay!

• As a result, free riding means ➔ willingness to pay of the free riders is not expressed in the market. – From the viewpoint of producers, free riding reduces

demand. The more free riding, the less demand. ➔ The less public good is produced!


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Role of Government in Supplying Public Goods• Due to the low demand caused by free riding, it’s

impossible for private firms to profitably provide public goods. ➔ No supply!

• If society wants a public good to be produced, it will have to direct government to provide it. – Due to nonexcludability, the government cannot

prevent free riding or charging people for it. – But because the government can finance the provision

of the public good through the taxation of other things, the government does not have to worry about profitability. ➔ Public goods supplied by government!


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Externalities

• An externality occurs when some of the costs or the benefits of a good or service are passed onto or “spill over to” someone other than the immediate buyer or seller.

• Such spillovers are called externalities because they are benefits or costs that accrue to some third party that is external to the market transaction.


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Negative Externalities

• Supply-side market failures

• These failures happen because producers do not take into account the costs that their negative externalities impose on others.

• Supply curves to shift to the right of where they would be if firms properly accounted for all costs.


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Over Allocation of Resources Caused by Negative Externalities• Equilibrium output Qe > Optimal output Qo.

• Resources are overallocated to the production of this commodity; too many units of it are produced.

• Net loss to society for every unit from Qo to Qe

because MC exceeds MB for those units.


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Examples of Negative Externalities• Costs of breathing polluted air that are imposed on

third parties living downwind of air polluting factories.– Because polluting firms do not take account of such costs,

they oversupply the products they make, producing units for which total costs (including those that fall on third parties) exceed total benefits.

• Airlines that fail to account for the costs that noisy jet engines impose on people living near airports.

• Biodiesel factories that convert dead animal parts into fuel release smelly gases that disgust those living nearby.


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Positive Externalities

• Demand-side market failures.• These failures happen because market demand curves fail

to include the willingness to pay of the third parties who receive the external benefits caused by the positive externality. – Shifts market demand curves to the left of where they would be

if they included all benefits and the willingness to pay of both the third parties and the primary beneficiaries.

• Markets fail to produce all units for which benefits (including those that are received by third parties) exceed costs. – As a result, products featuring positive

externalities are underproduced.


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Examples of Positive Externalities

• Vaccinations are a good example of how positive externalities reduce demand– When John gets vaccinated against a disease, he

benefits not only himself but also everyone else around him.

• These other people would presumably be willing to pay some money for the benefits they receive. – But because John’s vaccination is a public good,

there is no way to make them pay.


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Government Intervention

• To achieve economic efficiency when externalities affect large numbers of people or when community interests are at stake.

• Direct controls of negative externalities

– Engine emission standards

• Specific taxes

• Subsidies

• Government provisions


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Elasticity

• Price elasticity of demand

• Price elasticity of supply

• Income elasticity and cross elasticity


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Elasticity

• Why do buyers of some products (for example, ocean cruises) respond to price increases by substantially reducing their purchases?

• Why do buyers of other products (say, gasoline) respond by only slightly cutting back their purchases?

• Elasticity lets us know the degree to which changes in prices and incomes affect supply and demand.


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Price Elasticity of Demand

• Law of demand: other things equal, consumers will buy more of a product when its price declines and less when its price increases.

– But how much more or less will they buy?

• The responsiveness (or sensitivity) of consumers to a price change is measured by a product’s price elasticity of demand.


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The Price-Elasticity Coefficient

• Formula

– How should %change be computed?

• Midpoint formula

• Example: Price: $5 → $4 ➔ Quantity: 10 → 20

Using %change from $5 to $4: Ed = 100%/-20% = -5

Using % change from $4 to $5: Ed = -50%/25% = -2Using midpoint: Ed = (-10/15)/(1/4.5) = -3


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Interpretation of Elasticity|Ed|>1 |Ed|<1

|Ed|=1


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Selected Price Elasticities of Demand


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The Total-Revenue Test

• The importance of elasticity for firms relates to the effect of price changes on total revenue (the total amount the seller receives from the sale of a product). TR = PxQ

https://en.wikipedia.org/wiki/File:Total_revenue_test.gif2101337 Transportation Engineering -


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Determinants of Price Elasticity of Demand• Substitutability

• Proportion of Income

• Luxuries versus Necessities

• Time

• Demand is more elastic if:– Many (and close) substitutes

– Price of good is high relative to income

– Luxury good

– Longer time for adjustment


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Price Elasticity of Supply

• If the quantity supplied by producers is relatively responsive to price changes, supply is elastic.

• If it is relatively insensitive to price changes, supply is inelastic.

• Example:

Price: $4 → $6 ➔ Quantity: 10 → 14


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Supply and Time Period


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Cross Elasticity and Income Elasticity• The cross elasticity of demand measures how sensitive

consumer purchases of one product (say, X) are to a change in the price of some other product (say, Y).

• Income elasticity of demand measures the degree to which consumers respond to a change in their incomes by buying more or less of a particular good.


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What Sign of Elasticity Means?

• Positive cross elasticity of demand for X w.r.t Y:– X and Y are substitutes.

• Negative cross elasticity of demand for X w.r.t Y:– X and Y are complements.

• Positive income elasticity of demand for X:– X is a normal good.

• Negative income elasticity of demand for X:– X is an inferior good.


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Transport Economics

• Characteristics of transport demand and supply

• Transport market failures

– Transport externalities

– Transport as a public good

• Government’s roles in the transport system

– Regulation

– Cost-benefit analysis


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Demand for Transport

• The demand for transport is a derived demand.

• Users of transport are consuming the service not because of its direct benefits, but because they wish to access other services. (Charles, 2010)

• There would be no travel without the activities being undertaken at the trip ends.


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Characteristics of Transport Demand• Demand can be measured in

– number of trips made– total distance traveled across all trips (e.g. passenger-kilometers

for public transport, vehicle-kilometers of travel (VKT) for private transport, or Ton-kilometers for freight transport).

• Transport demand changes with generalized transport costs.

• Demands peak.• Induced demand or induced traffic

– After supply increases, price (GTC) declines and more of a good is consumed.


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Peaking Demand for Transport


https://transportgeography.org/?page_id=5688

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https://upload.wikimedia.org/wikipedia/commons/f/f2/Vicious_Cycle_of_Automobile_Dependency.png2101337 Transportation Engineering -


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Transport Demand Elasticities


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Transport Demand Elasticities With Respect to Fuel Price


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Generalized Transport Costs

• In transport economics, the price of the good is measured using the generalized costs.

• Generalized transport costs are the sum of the monetary and non-monetary costs of a trip (Koopman et al 2013). – Monetary or actual “out-of-pocket” expenses : a fare on a

public transport journey, the costs of fuel, parking charges, tolls or congestion charges on a car trip.

– Non-monetary costs of a trip: the time spent undertaking the trip, unreliability of travel times, frequencies of public transport lines, the possibility of getting a seat during a train ride, and other ease and convenience aspects.

• Simple example: A train trip costs $3 and takes 15 min. If the value of time (VOT) = $10/hour, – generalized costs = $3 + (15/60)*$10 = $5.5


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Characteristics of Transport Supply• The transport networks may not be competitive.

– Example, Railways: The very high costs of laying track, as well as the costs of buying or leasing the trains, would prohibit the entry of a competitor.

• To society, the costs associated with building and running a rival network would be wasteful.

• Railways are a typical example of a natural monopoly.

• Network effects

– the value of the transport service increases according to the number of destinations it reaches.


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Economies (and Diseconomies) of Scale• Economies of scale: when cost per unit of

output decreases as the scale of production grows.


https://commons.wikimedia.org/wiki/File:Economies_of_scale.svg

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Transport System with Economies and Diseconomies of Scale• Lightly used (uncongested) transport

infrastructure: roads, bridges, etc.

• Infrastructure with large investment: railways, airports

– As usage increases, cost per user decreases. ➔ EoS

– The price should be kept low to encourage more use.

• Congested transport infrastructure:

– As usage increases, cost per user increases. ➔ DoS

– The price should be high to discourage more use.


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Transport Market Equilibrium


https://transportgeography.org/?page_id=5676

Supply increases from S1 to S2 by capacity expansion.

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Benefits from a Fall in Price

• Consumers’ gain from a fall in price can be evaluated by the increase in consumer surplus.


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Benefits of Transport Supply Increase


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User Benefits from Transport Supply Increase: Rule of One-Half


Guide for Conducting Benefit-Cost Analyses of Multimodal, Multijurisdictional Freight Corridor Investments (2017) https://www.nap.edu/read/24680/chapter/16

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Using Elasticity for Forecasting Changes in Demand Quantity• Elasticity formula

• Given P2, Q2 can be computed by the so-called Pivot Point method.


𝐸𝑑 =Τ∆𝑄 𝑄

Τ∆𝑃 𝑃=

Τ(𝑄1 − 𝑄0) 𝑄0Τ(𝑃1 − 𝑃0) 𝑃0

𝑄2 = 𝑄0 + 𝐸𝑑 ∙ Τ(𝑃2 − 𝑃0) 𝑃0 ∙ 𝑄0

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Example Benefit Estimation of Highway Expansion• A congested 2-lane undivided highway in an

urban area has a traffic volume of 4000 trips per day and a generalized cost of $10 per trip.

• Estimate the benefit of a project to expand the highway to 4 lanes that will reduce the generalize cost to $8 per trip.

• Step 1: Use the demand elasticity of -0.47 to determine the change in traffic volume.T1 = T0 + Ed * (C1-C0)/C0 * T0

T1 = 4000 + (-0.47)(8-10)/10*4000 = 4376


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Example Benefit Estimation of Highway Expansion• Step 2: Use the Rule of Half to calculate the

gain in consumer surplus.

∆CS = ½ (C0-C1)(T0+T1) = ½ (10-8)(4000+4376)

= 8376


10

8

4000 4376

=8376

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Externalities

• Positive externalities of transport networks may include increases in land value and agglomeration benefits.

• Negative externalities are wide-ranging and may include local air pollution, noise pollution, light pollution, safety hazards, community severance, congestion, and climate change.


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Congestion

• Traffic volume (demand) >> capacity (supply) ➔Congestion

• Not limited to road networks, but also transit networks, airports, etc.

• Supply-side solution: why not increase capacity? – Capacity expansion is a potential mechanism to deal with

traffic congestion but may produce undesirable outcomes.

– Congestion may be reduced at first but may soon return due to induced demand.

– If we increase capacity to accommodate peak demand, there will be excess capacity off-peak ➔ wasteful


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Congestion Pricing

• Economists consider congestion pricing an appropriate mechanism to deal with this problem (i.e. to internalize the externality) by allocating scarce roadway capacity to users.

ERP Gantry at North Bridge Road, next to PARCO Bugis Junctionhttps://commons.wikimedia.org/wiki/File:ERPBugis.JPG Economic rationale for moving from untolled equilibrium to congestion pricing

equilibrium. David Levinson https://en.wikipedia.org/wiki/Congestion_pricing2101337 Transportation Engineering -


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Road Space Rationing• Also known as alternate-day

travel, driving restriction, or no-drive days

• Restricting traffic access into an urban core area or city center (CBD) based on the last digits of the license number on pre-established days and during the peak hours.

• Considered more equitablethan congestion pricing but high-income users can avoid the restrictions by owning a second car.

By Transformative Urban Mobility Initiative (TUMI) - Own work, CC BY-SA 4.0, https://commons.wikimedia.org/w/index.php?curid=79626082


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References

• economicsonline.co.uk https://www.economicsonline.co.uk/Business_economics/Natural_monopolies.html

• Koopman et al 2013 https://doi.org/10.1016/j.tranpol.2013.05.005

• Charles 2010 https://transportfutures.institute/


https://www.economicsonline.co.uk/Business_economics/Natural_monopolies.html

https://doi.org/10.1016/j.tranpol.2013.05.005

https://transportfutures.institute/

Transportation Economics I

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