Day 1 - Economic Principles in Transport - LH
Transcript of Day 1 - Economic Principles in Transport - LH
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CEG8413
Economic and Environmental Appraisal ofTransport Activities
Economic Principles inTransport Appraisal
Lionel [email protected]
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Objective of lecture
To provide an overview of the way in whicheconomic principles are applied to transport
projects
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Outline
What is economics? Economics of Transport Policy Demand (for road space)
Supply (of road space) Investment (in roads) Investment appraisal
Externalities
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What is Economics?
The study of how we, as individuals and as a
society, choose to use the limited resources
(land, labour, capital) at our disposal.
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Economicssubject matter
Microeconomics
price of petrol car manufacturers parking charges
bus fares
Macroeconomics
economic growth inflation national debt
unemployment transport policy
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Passenger transpo rt in Great B ri tain(percentage of passenger ki lometres b y mode of transpo rt)
Year Cars Motorcycles
Buses andcoaches
Bicycles Rail Air
1957 38 4 34 7 17 0.2
1967 70 2 17 2 9 0.5
1977 77 1 13 1 7 0.5
1987 83 1 8 1 6 0.7
1997 86 1 6 1 6 0.9
2007 84 1
6 1 7 1.2,)
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Economics of Transport Policy
Why does this increase in car usage matter? congestion time wasted
working time and leisure time
more accidents
more pollution
Governments have transport policies to addressthese issues
Economics has an important part to play inthese policies
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Demand
Demand for road space (by car users, i.e. privateindividuals)Deriveddemand
Determinants of demand Price (i.e. cost of driving)
Negative relationship
Price elasticity of demand Income
Positive relationship
Income elasticity of demand
Substitutes Public transport
Bus and train fares; cross price elasticity of demand
Complements Parking charges, tolls; cross price elasticity of demand
Tastes Car as status symbol
Environmental awareness
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Typical demand curve
D
Price
Quant i ty0
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Demand
Elasticity
In general, elasticity is the responsiveness of one
variable to a change in another variable
Price elasticity of demand is the responsiveness ofdemand for a product to a change in the price of that
product
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Demand
(Own) Price elasticity of demand (PD)
Definition:Percentage change in quantity demanded
__________________________________
Percentage change in price
Example:
If a 10% rise in the price (i.e. cost) of motoring results in a 3% fall in the demand for
road space (i.e. motoring),
PD = -3% / 10% = -0.3
Interpretation:
A 1% rise (fall) in the price of motoring causes a 0.3% fall (rise) in motoring and
therefore in the demand for road space
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Demand
Points to note about PD
use of percentage changes
sign (usually negative)
(absolute) value
elastic (>1)
inelastic (
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Demand
Income elasticity of demand (YD
)
Definition:Percentage change in quantity demanded
____________________________________
Percentage change in disposable income
Example:
If a 4% rise in disposable income results in a 5% increase in the demand for cars,
YD = 5% / 4% = 1.25
Interpretation:
A 1% rise (fall) in disposable income causes a 1.25% rise (fall) in the demand for
cars
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Demand
Points to note about YD
degree of necessity of the good
luxury (>1)
normal (0-1)
inferior (
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Demand
Cross price elasticity of demand (XPD)
DefinitionPercentage change in quantity demanded of good A
_____________________________________________
Percentage change in price of good B
Example
If a 8% rise in the price of motoring results in a 4% increase in the demand for
public transport,
XPD
= 4% / 8% = 0.5
Interpretation
A 1% rise (fall) in the price of motoring causes a 0.5% rise (fall) in use of public
transport
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Demand
Points to note aboutXP
D
Measurement
positive for substitutes
negative for complements
Determinants number & closeness of substitutes or
complements
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Supply
Supply of road space Provided by government (central and local)
Short run Fixed or constant
Long run
Build more or improve existing roads
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Typical supply curve
S
Price
Quant i ty0
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Supply curve for roads in short run
S
Price
Quant i ty0
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Supply and Demand
How to equate supply with demand to achieve asocially optimal level of road use? Supply side
Provide more roads and/or improve existing roads
Demand side Increase car and road taxes
Parking restrictions and charges
Restrict car access
No-car lanes, pedestrianisation
Road pricing!
Provide more public transport
Subsidise public transport
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Market equilibrium
D
Price
Quant i ty0
S
Pe
Qe
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Investment (in roads)
Suppose the government decides to provide more roads or
improve existing roads
What are the benefits?
Time saved Working time
Leisure time
Reductions in operating costs
Less fuel (e.g. by-pass)
Reductions in accidents
Lower costs of emergency services
Savings in human life and health
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Economic and Environmental Appraisal of Transport Activities
Investment (in roads)
What are the costs? Construction
Maintenance
Environmental
Evaluation of benefits and costs using Cost-Benefit Analysis(CBA)
comparison of with vs without
benchmark or baseline
Funding Interest rate
the cost of borrowing money
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Investment Appraisal
Roads are durable and therefore calculating theirbenefits and costs involves a TIME dimension
Different measures of investment appraisal, but sameapproach
Net Present Value (NPV)
Benefit to Cost Ratio (BCR)
Internal Rate of Return (IRR)
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Investment Appraisal
Net Present Value (NPV) First, convert all future benefits to apresent value The principle of discounting: people generally prefer to have benefits
today than in the future. Thus future benefits have to be reduced(discounted) to give them a present value.
Suppose benefits of 1,000 per year for 20 years. What is the presentvalue of this benefit stream?
PVB = [Xn/ (1+r)n]
where,
PVB is the present value of benefits
n is the year in which benefit occurs
Xnis the benefit in year n
r is the rate of discount
n = 0 is the present value year
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Investment Appraisal
Suppose the rate of discount is 3.5%
1000 1000 1000 1000
PVB = ------ + ------- + -------- + . + -------
1.0350 1.0351 1.0352 1.03519
= 1000 + 966 + 934 + . + 520
= 14,710
Thus, PVB is 14,710 not 20,000
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An Aside - Inflation
Discounting is not done because of inflation! Definition of inflation
A general rise in prices throughout the economy
measured by price indices
RPI and CPI
In CBA all prices are expressed in real terms,i.e. inflationary effects are removed prior todiscounting
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Investment Appraisal
We then do the same for costs
Suppose these occur only in the first three years and are: 7,000,5,000 and 2,000. We use the same formula, but substitute costs
for benefits
Therefore, the present value of costs (PVC) is:
7000 5000 2000
PVC = ------ + ------- + --------
1.0350 1.0351 1.0352
= 7000 + 4831 + 1867
= 13,698
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Investment Appraisal
If we then subtract the PVC from the PVB, we have the Net PresentValue (NPV)
NPV = PVBPVC= 14,71013,698
= 1,012
Generally, if NPV is positive, then investment is worthwhile.
This is an example of CBA
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Investment Appraisal
Benefit to Cost Ratio (BCR)
Use PVB and PVC, but express as a ratio:
BCR = PVB / PVC
= 14,710 / 13,698
= 1.074
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Investment Appraisal
Internal Rate of Return (IRR)
Use same approach as for NPV, but find r such that NPV =0, i.e. the rate of discount at which PVB equals PVC
This is the IRR
If IRR is greater than the cost of borrowing money (interestrate), then project usually deemed worthwhile
In our example, the IRR is approximately 4.5%
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Externalities
Externalities are spillover (or indirect) costs orbenefits which affect people other than those
who are directly responsible
Negative externalities (costs) are the morecommon, e.g. pollution
In principle, CBA should account for all costs
and benefits; this includes any externalities
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Externalities
Examples: Environmental
Pollution Air, Noise
Loss of natural habitats
Congestion
individual car users add to congestion suffered by others in terms
of:
Time lost
Increased running costs (e.g. extra fuel, stopping and starting)
These externalities should be evaluated, discounted andincluded in the CBA, but not always done
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References
There are many standard economic textbookscovering the material in this lecture
E.g., (parts of) Sloman, Hinde and Garratt (2010)Economics for Business, 5thedition, Pearson
Education See also
http://www.dft.gov.uk/webtag/documents/expert
/unit3.5.phpespecially Tag 3.5.4 on CBA
http://www.dft.gov.uk/webtag/documents/expert/unit3.5.phphttp://www.dft.gov.uk/webtag/documents/expert/unit3.5.phphttp://www.dft.gov.uk/webtag/documents/expert/unit3.5.phphttp://www.dft.gov.uk/webtag/documents/expert/unit3.5.php