Day 1 - Economic Principles in Transport - LH

8/12/2019 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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Economic and Environmental Appraisal of Transport Activities

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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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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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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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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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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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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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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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

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Day 1 - Economic Principles in Transport - LH