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People all over the world must use the earth’s natural resources to satisfy the necessities of life – food, clothing and shelter. In addition, people will often seek items beyond the necessities in order to make life more pleasant, comfortable or rewarding. The natural resources of the earth are not uniformly distributed and therefore transport is required to bring the resources to people, or to bring people to the resources. As well, people will transport in order to bring services to others or to seek services e.g. medical services.
Economics is primarily concerned with the production, distribution and consumption of goods and services which are of value to people.
Economists conveniently divide the broad area of economics into two main streams:
Transport engineers generally work in the microeconomic area because they are involved in the detailed planning, construction and maintenance of specific transport projects. These projects all lead to small savings in economic resources which generate microeconomic benefits and an increase in the welfare of the community. However it should be noted that the sum total of the microeconomic effects of individual transport projects will impact on macroeconomic factors such as infrastructure spending and employment.
The demand for goods and services depends largely upon consumer income and the price of the particular good or service relative to other prices. For example the market for expensive luxury cars is fairly restricted as only a small number of people in society have an income large enough to consider the purchase of such an item, particularly when lower priced cars will still fulfil the requirement of getting the motorist from one point to another.
In a more general way, the demand for travel will depend on the income of the traveller. The choice of travel mode depends on several factors such as the purpose of the trip, the distance to be travelled and the income of the traveller.
A demand function for a particular product represents the willingness of consumers to purchase the product at alternative prices. A demand function shows, for example, a number of passengers willing to use a bus service at difference price levels between a pair of origins and destinations, for a specific trip, during a given period.
The term price represents all the perceived outlays that the traveller will have to make for a given trip. This would include the cost of the fare, but would also include the cost of travel time, comfort, safety, reliability. The fare of course is a tangible cost but several of these other factors are intangibles. Most of the components of the perceived price for travel are measured and expressed in monetary units. This synthetic ‘price’ is sometimes called a generalised price.
A knowledge of the functional form of travel demand can be used to forecast changes in the volume of travel caused by specific changes in price in the short run.
A useful description for explaining the degree of sensitivity to a change in price (or some other factor) is the elasticity of demand. The elasticity of demand is the percentage change in quantity of trips demanded which accompanies a 1% change in price.
If for example a 1% increase in the price of bus trips results in a 5% decrease in the number of trips, the elasticity of demand for trips is 5.0.
When the elasticity is greater than 1 the demand is described as being elastic, meaning that the resulting percentage change in quantity of trip making will be larger than the percentage change in price. In this case demand is relatively sensitive to price change. However, when the elasticity is between 0 and 1, the demand is described as being inelastic or relatively insensitive.
Consumer surplus is a measure of the monetary value made available to consumers by the existence of a facility. It is defined as the difference between what consumers might be willing to pay for a service and what they actually pay. For example a commuter may pay $3 per trip, but may be willing to pay up to $4 per trip. In this case the consumer surplus would be $1.
In general, a transport improvement can be measured in terms of the change in consumer’s surplus.
It is essential to have a knowledge of costs, or the value of a product or service.
Fixed costs are inescapable costs which do not vary with the quantity of production. For example if we are operating a fast food restaurant we will have fixed costs of rent, hire or lease of equipment, etc. which will have to be met whether we sell one hamburger or 10000 hamburgers. However the fixed cost per unit of production will decrease with the more units produced.
Variable costs, on the other hand, increase with output or production. For example we use 1000 times more meat in 1000 hamburgers than we use in one. However if it costs us $0.50 in labour and heating to cook one hamburger, it may only cost $0.47 per hamburger for the production of two, or $0.42 per hamburger for one hundred.
The total cost of production is the sum of the fixed and variable costs and will increase with production. For any particular level of production, the average cost per single unit can be found by dividing the total cost for that level of production by the number of units produced.
The marginal cost of a product is defined as the additional cost associated with the production of an additional unit of output. This is an important concept.
Pricing is a method of resource allocation.
There is no such thing as the ‘right’ price but rather there are optimal pricing strategies which permit specified goals to be obtained. The optimal price, for example, to achieve profit maximisation (say for a private bus operator) may differ from that needed to maximise welfare (e.g. for a government operated bus service) or to ensure the highest sales revenue. In some cases there is no attempt to set a price which maximises or minimises anything, but rather prices are set that permit some other objectives to be achieved (e.g. security, minimum market share, etc.).
Further, prices may be set to achieve certain objectives for the transport supplier’s welfare, while in other fields prices may be set to improve the welfare of consumers.
One of the major problems in discussing pricing policies in practice is to decide what exactly the objective is. Profit maximisation is the traditional motivation of private enterprise undertakings. The actual price level in this case depends upon the degree of competition in the market. Where competition is high, then no single supplier has any control over price and must charge that determined by the interaction of supply and demand in the market as a whole. Within such a competitive environment it is impossible for a supplier to make super-normal profits in the long run because if super-normal profits exist, other competitors will enter the market and increase overall supply.
In contrast, if a transport supplier has a monopoly on the supply of services, and has no fear of new entrants increasing supply, then prices can be set at any level the supplier desires, or the supplier can specify what level of service is to be provided.
However there are few natural monopolies in transport. Modes are normally competitive even if they have a tendency towards a monopoly. Also users of transport services often have the alternative of either changing their method of production (in the case of freight transport) or pattern of consumption (in the case of passenger transport), so that transport is itself competitive with different forms of human activity.
Welfare economics takes a wider view of pricing, looking upon price as a method of resource allocation which maximises the welfare of the society rather than simply the welfare of the supplier. In some cases, when the good or service is provided by a public agency, the supplier’s welfare and social welfare will be the same thing. In other instances controls or incentives may be applied to private companies so that their pricing policy is modified to maximise social rather than private welfare.
One of the most important forms of transport infrastructure in Australia, as in most countries, is the road system. The pricing problems that have been alluded to in the previous section can be illustrated by examining some of the main issues involved in charging for road space.
In Australia no direct charge is usually made for using a public road, although motorists are required to pay tolls on a small number of expressways, motorways and bridges. Road space is thus provided ‘free’ in most circumstances. However road users can be said to contribute towards the cost of roads via fuel levies and other motoring charges such as licence and registration fees.
Consider some figures for 1994/95. Governments in Australia (predominantly the Federal Government) raised $9494 million in taxes on fuel. Another $4183 million was raised through taxes based on vehicle ownership of vehicles (as distinct from the amount of their use). A total of $15 588 million was raised as revenue from road users.
The total expenditure on roads was $5707 million, and the difference (approx. $9900 million went into consolidated revenue (i.e. was spent on other Government spending initiatives not roads). It is this differential between revenue collected and funds spent which gives rise to a lot of argument from the motoring public, motoring organisations, state and local highway authorities, and other groups.
The other method of charging for road use is via direct user charges whereby the actual ‘time’ or ‘distance’ of vehicle travel is monitored and charged. Traditional toll collection consists of payment at a point or barrier for entry onto a facility (e.g. road, bridge or tunnel). Developments in direct charging include the use of electronic systems using fixed beacons and on-vehicle transponders. Many road authorities are now considering charging not only for special purpose facilities (e.g. toll roads and harbour tunnels) but also for use of the normal road system, particularly in areas subject to traffic congestion. The concept is that with a limited supply of physical resources, the only realistic option is some form of traffic restraint and stricter management of actual traffic demand. This is best achieved through using effective pricing mechanisms in order to attain better utilisation of the existing road space.
Another issue associated with road funding has received a significant amount of attention in recent years. This is the issue of the contribution made by different categories of road users, and in particular whether heavy vehicles pay their fair share for road use. From engineering considerations there is no doubt that heavy vehicles result in increased road costs through their damaging effects. It has been argued that there is a case for increased taxation of road vehicles and that such taxation should be directly related to the damage being caused to the road.
Although it may be possible to reach consensus that a relationship should exist between the taxing of commercial vehicles and the extent of costs which have to be borne by public authorities in maintaining roads, the problem of deciding on the basis of allocating those costs between different types of vehicles and scales of operation remains extremely difficult. The importance of devising an equitable basis of allocation increases as the move to allow heavier goods vehicles gains political momentum.
However, it may also be considered that no vehicles ‘cause’ road expenditure. Rather, they have an effect on design standards and maintenance which is a response to their effect. Therefore to burden heavy transport operators with charges above those of other road users is unfair, as road authorities have as their charter to provide safe and trafficable roads for all road users.
Both the overall funding and heavy vehicle issues tend to be argued largely from the point of view of cost recovery, i.e. the road user generally, or truck operator in particular, paying for the use of government provided roads.
Page last modified 24 June 2002.