Day 1 1430 Selena Sheng

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Transport Economics

Energy Summer School, 2017


Selena Sheng
Energy Centre, Business School, UoA
27/02/2017
Transport Economics

• Transport demand
• Transport supply
• Congestion pricing
• Econometric modelling for demand forecast
Transport Demand
• Derived demand
• An individual’s demand for transport is instigated through their demand for
something else.
• Transport is not typically consumed because people like travelling, but because
transport supports other activities (i.e. JTW commuting, the movement of freight)
• Time specific
• When transport services are demand they are demanded NOW.
• People generally travel to engage in activities at various locations at specific time
period – demand for transport has a very short ‘expiry date’.
• Follows peaks and troughs
• The morning & afternoon rush hours – significant impact upon the way in which
transport services are provided and indeed the whole ‘economics’ pf transport
operations.
Microeconomic Theory
• What determines the demand for a particular journey or the demand
for a particular mode of transport?
• What may happen to the level of congestion if a road pricing system is
introduced?
• How can an airline operator charge passengers different prices for the
same flight when schools are ‘in session’ or ‘on holidays’?
• What are the effects of a change in the price of petrol on private car
usage?
The Demand Function
• A key component of any form of economics
• The willingness of consumers to purchase the product at different prices (of
different expenditures of resources)
• Relates price (cost to the consumer) and quantities demanded
• Can be expressed in terms of a number of “prices”
• Fare
• In-vehicle time
• Overall generalised travel cost
• Assumptions:
• Consumer utility maximisation
• Rationality: as the price increases the quantity demanded reduces
• Ceteris Paribus: a number of the other characteristics of the journey and of the
traveller remain constant.
A Typical Linear Demand Curve
Equation: p = α – β q
Where q is the quantity of trips demanded, p is the price and α and β are
constant demand parameters

Price of trips, P
α

B
PB
A
PA Demand Curve

qB qA α Number of trips, Q
β
Characteristics of the Demand Curve
• Equation of form p = α – β q
• When price = 0, quantity demanded q = α/β
• When price = α, quantity = 0
• Negative relationship with price means curve slopes downwards as
prices increase
Shifts Along and Between Demand Curves
• Along demand curve possibly under control of operator
• Short term changes
• Between demand curves more general changes or changes
in other modes
• Often longer term and may be outside control of transport
operator
Factors Affecting Demand
Factors Affecting
Demand

Exogenous Variables Endogenous Variable


(shifts between (movement along
demand curves) demand curves)

Price of the
Price of Weather good itself
Tastes Income Population Advertising
other goods
Movement along the Demand Curve
Price of For example, an increase in
Trips, P
the bus fares results in a
B movement along the
$4.00 demand curve of buses.

A
$2.00

Demand Curve
0 12 20
Number of trips, Q
Shift between Demand Curves
For example, an increase in
D3
Price of Trips, P consumer’s income will lead
D2
to an increase in demand.
D1 Demand Curve will shift to
the RIGHT.

P1

q1 q2 q3
Number of trips, Q
• Factors other than “price” changing
The Elasticity of Demand
• Need to understand how demand changes if we alter the cost to the
traveller of a service
• Elasticity of demand
• Measures the change in demand in response to changes in the
“price” of the service
• Proportional change in quantity divided by the proportional change in
“price”
Elasticity Formula
• Price elasticity of demand; Or
• Elasticity of demand with respect to price

q / q q p
ep   
p / p p q

where q is the change in the number of trips that accompanies , the


change in price p
Calculating Elasticities
• If fare increases from $1.0 to $1.1
• Proportional increase in fare
= (1.1-1.0)/1.0 = 0.1 or 10%
• Quantity demanded changes from 100 to 97
• Proportional decrease in quantity demanded
= (97 – 100)/100 = -0.03 = -3%
• Elasticity therefore = -0.03/0.1 = -0.3
Transport Supply -1
• Who supplies transport
• Government
• Private sector
• What is supplied
• Infrastructure
• Transport services
Transport Supply -2
• Private sector – financial criteria
• Flow of funds to generate income
• But may come from subsidy or similar source
• Revenues greater than costs
• Need for precise assessment
• Government – ideally social welfare criteria
• Need to be sure that benefits > costs
• Financial criteria is important in funding of schemes
Transport Supply -3

Price of trips, P
• As in case of
transport demand,
transport supply Supply Curve
B
also reveals the PB
relationship
between market A
price and quantity PA
supplied
• Quantity is based
on what suppliers
are prepared to qA qB Number of trips, Q
offer
Costs of Production
• Costs of production is a major determinant of the level of supply
• Supplier needs revenues to cover costs (types costs will be examined
later).
• Profit = Revenue – Cost
• All transport operators are assumed to be profit maximisers:
• An increase in cost will decrease the supply: some operators will leave the
market due to a loss in profit
• A reduction in costs will increase in supply: existing operators will supply
more to the market & new entrants will enter the market due to higher profit
opportunities.
Market Equilibrium
• We drew the transport market demand curve on a graph with
P on the vertical and Q on the horizontal
• We did the same for transport supply...
• Hence we can actually show transport demand & supply on the
same graph, with P on the vertical and Q on the horizontal
• What is happening at the point where they cross...?
• At this point we have an ‘equilibrium’
The Market at Equilibrium

Price of supply
trips, P

Pe

demand

Qe Number of trips, Q
What is Equilibrium?
• Equilibrium is a stable situation that occurs in the market when
quantity demanded in the market is equal to quantity supplied in the
market
• On the graph this appears as the intersection of the market demand curve
and the market supply curve
• This occurs at one unique (single) price and quantity
• What is this price? What is this quantity?
• At this point demand = supply  quantity demanded = quantity supplied
(there is no over- or under-supply of the commodity)
• We say the market ‘clears’ at equilibrium
Determination of Price in a Competitive Market -1

 If the price is set below


Price of trips, P supply
the equilibrium price,
there will be an excess
demand, which leads to a
shortage
Pe  At P1, buyers want QD
P1 but sellers are only willing
shortage
to sell QS

demand

QS Qe QD Number of trips, Q
Determination of Price in a Competitive Market -2

 If the price is set above


Price of trips, P supply
the equilibrium price,
surplus
there will be an excess
P1 supply, which leads to a
surplus
 At P1, sellers are willing
to sell QS but buyers are
only willing to buy QS

demand

QD Qe QS Number of trips, Q
What are Externalities?
• An external cost is a cost that is not borne by either the buyer or the
seller of the service - it is imposed on a third party
• Externalities occur whenever someone other than the producer and
user of the transportation service are affected by the act of
transportation
• Most prevalent external cost: traffic congestion
• Other external costs of transportation: noise, air vibration, glare, and
water pollution
Traffic Congestion
• Travel demand is mainly a derived demand
• AM and PM peak – temporal
• Because the capacity of the road is limited, congestion externalities
arise
• Some degree of congestion is desirable, excessive congestion is not
• What is the optimal level of congestion??
Congestion Pricing – 1

ASC = MPC
Users ignore the costs they
impose on others
Actual Flow = q0

Marginal Congestion Cost


= MSC - ASC

Optimal Flow = q*
Congestion Pricing – 2

• Optimal Charge = DE

• Optimal Flow = q*

• Deadweight loss =
Welfare Gain = DMC
Econometric modelling for demand forecasting -1
• The objective of econometric methods is to try and identify the
precise importance of each of the factor that broadly determine the
demand for transport (income, price of the service, quality of the
service, price and quality of alternatives, journey time and population
size, etc.), in order that we can determine the effect on demand of
changing these in the future.
Econometric modelling for demand forecasting -2
1. Understanding the problem:
Identifying all the key factors and making preliminary estimates of the size and
direction of the effect.
2. Obtaining the data:
Data on ALL the factors has to be acquire.
a) Time series: where the data, going back a significant number of years,
relates to a single location
b) Cross Section: where the data has been obtained from a series of locations
(or individuals) at a specific point in time
c) Panel data: where data has been obtained from the same series of locations
over a period of years.
Econometric modelling for demand forecasting -2
3. Specifying the model:
a) Selecting the functional form (i.e. linear, log-log)
b) Selecting the variables and in time series any lagged effects
c) Making reasonable assumptions about the error term
4. Estimating the specified model:
Identifying values for the parameter estimates for each factor to be used in the
forecast, that makes the predicted values lie as close as possible to the actual
values. This normally involves minimising the sum of squares of the residuals.
Econometric modelling for demand forecasting -3
5. Validating the model:
a) The values of the coefficients (the elasticities in log-log) have the right signs (i.e.
income +, price -) and are of the expected size.
b) The model fit is statistically significant (The R2 in the output table)
c) The individual variables are statistically significant (the p value in the output table)
d) The residuals have no pattern over time or location (i.i.d)
6. Simulation/Forecasting:
Once we have the final model then it is a question of inserting expected future values of
the factors into the equations. Sometimes we use suggested values obtained from expert
groups, or use different sets of predictions to form scenarios, or simply use trend
extrapolation of the external factors.
Econometric modelling for demand forecasting -4

log Qt = α + β1logYt + β2logPt + β3logJt + β4log Ft + εt

where Qt is the number of passengers, Yt is income, Pt is relative price,


Jt is relative journey time and Ft is relative frequency, at time t. The
parameter estimates are the average relative impact (%) on demand of
each of the factors included, taking into account the units in which
each is measured.
References
1. Sheng, S. (2016). CIVIL770 Coursebook. Transport Systems
Economics, Department of Civil and Environmental Engineering,
UoA.
2. Cowie, J. (2010). The economics of transport: A theoretical and
applied perspective. London; New York: Routledge.

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