The Importance of Transportation Economics Serdar AYAN, Phd. Visiting Professor

Transportation and Economics Economics is the study of how societies use scarce resources to produce valuable commodities and distribute them among different people. Transportation allows the bakery firm to use the most efficient technology in producing bread A similar example with economies of scope would be if there are economies of scope in producing bread and donuts – i.e. its cheaper to produce bread and donuts together in one firm than to produce them separately – if one town eats only bread and the other town only donuts, low cost transportation may allow a firm to produce both products in one town and ship to the other at a lower cost than producing them separately in the two cities

Importance of Transportation 1. Transportation Provides the Opportunity for Economic Specialization – Comparative Advantage - Transportation allows countries or regions to produce what they produce best and then trade - The specialization that results from the ability to exchange results in a higher standard of living for the exchanging regions

Importance of Transportation Should A area produce oranges or should it get them from B? Since labor, land, and capital could much more efficiently produce wheat than oranges, there is a high opportunity cost of producing oranges in A – Supply should be limited A citizens like citrus fruit as much as anybody, and substitutes are not readily available – Demand should be strong in A The opportunity cost of producing oranges in the A area is foregone production of other commodities Since a lot of wheat could be produced with the resources used for producing oranges, the opportunity cost of producing oranges is high A high opportunity cost of producing oranges in the Fargo area means that people will only produce oranges if the price is high – i.e. if the price of oranges isn’t high, people will use resources to produce wheat and other products that can more efficiently be produced with Fargo’s resources That is, supply will be limited – for each price less will be supplied Remind students about difference between supply and quantity supplied

Importance of Transportation Should A produce oranges or should it get them from B? Supply P If A produced its own oranges, the price per pound would be 6 EU, and 2,000 pounds per week would be sold at prices lower than 6 EU, there is excess demand – few would be willing to supply oranges at lower prices and a lot would want to buy them at that price - at prices above 6 EU there is excess supply EU 6 Excess demand refers to a situation where the quantity demanded is greater than the quantity supplied Excess supply refers to a situation where the quantity supplied is greater than the quantity demanded As long as prices are freely set, a situation of excess supply or excess demand can not exist – the price mechanism will adjust to eliminate any excess demand or supply Demand 2,000 Q A Market for Oranges in Isolation

Importance of Transportation Should A produce oranges or should it get them from B? P Supply EU 2 The supply of oranges is much higher in B than in A – they can be produced much more cheaply in B At prices for oranges below 2 YTL in B, there is excess demand – this excess demand increases the further price falls below 2 YTL – graph this At prices above 2 YTL, there is excess supply – this excess supply increases the further price increases above 2 YTL – graph this Demand Q 5,000 B Market for Oranges in Isolation P Excess Supply $2 Q

Importance of Transportation Should A produce oranges or should it get them from B? A B Amount Traded S S Excess Supply For any price above 2YTL, there will be an excess supply of oranges in B And as price increases, this excess supply increases For any price below 6YTL, there will be an excess demand for oranges in A And as price decreases, the excess demand increases Equilibrium is reached when excess supply and excess demand are equal – after transportation cost is taken out 2,000 pounds of oranges are shipped from B to A, the price of oranges in B is 3.50YTL, the price in A is 4.00YTL, and transportation Cost is .50YTL per pound There is a gain in societal welfare from this trade In A, there is resource savings from reducing production from 2,000 pounds to 1,500 pounds – these resources can be put into other productive uses – and there is an increase in available consumption of 1,500 pounds In B, there is a revenue increase from selling an additional 1,500 pounds of oranges, and there is a gain from reducing consumption on 500 units where the marginal benefit received by those 500 units is less than the revenue received from them (the opportunity cost of consuming them). EU 6 4 3.5 2 D Excess Demand D 4,500 6,500 2,000 1,500 3,500

Importance of Transportation 2. Transportation Allows Firms to Take Advantage of Scale Economies Economies of Scale – Average costs decrease with increased production Example Suppose A and C Each Demand 20,000 Loaves of Bread per Day The Transportation Rate Between A and C is 0.10 EU per Loaf Economies of scale are reductions in average cost resulting from increasing output Why? Product specific – new production techniques with more volume, learning by doing Plant specific – larger plants, equipment, machines do not increase in cost proportionately to capacity – also, reserve machine for breakdown – workforce specialization Multi plant – employ specialized accountants, marketers, specialization among plants Economies of scope are reductions in average cost resulting from producing multiple outputs – often the result of a shared input

Importance of Transportation EU .50 .30 Average Cost 20,000 40,000 Q

Importance of Transportation If each community produces 20,000 Loaves Total Costs = 20,000 EU Production costs = 40,000 (.5) = 20,000 EU Transportation costs = 0 EU If C or B produces all 40,000 loaves and ships 20,000 to the other Total Costs=14,000 EU Production costs =40,000(.3) = 12,000 EU Transportation costs = 20,000(.1) = 2,000 EU Transportation allows the bakery firm to use the most efficient technology in producing bread A similar example with economies of scope would be if there are economies of scope in producing bread and donuts – i.e. its cheaper to produce bread and donuts together in one firm than to produce them separately – if one town eats only bread and the other town only donuts, low cost transportation may allow a firm to produce both products in one town and ship to the other at a lower cost than producing them separately in the two cities

Importance of Transportation 3. Transportation Has an Impact on Land Prices and Land Uses Example : Milk farmers gain profits by selling milk in the market Land prices are determined by values placed on land for alternative uses For milk producers, the value of a particular parcel of land depends on how good it is for producing milk and how costly it is to get that milk to customers - Why are land prices determined by the values placed on land for alternative uses? – if land is very valuable for some use, people will bid a high price for that land – e.g. profit opportunity

Importance of Transportation Assume that all land is equally good for producing milk, and that all customers are in the central city The value of owning a parcel of land for a year will be a function of the yield of milk that land can produce in a year, the market price of milk, the production cost of milk, and the transportation cost to the market (which depends on distance to the market) Rent = Yield*(mkt prce/unit – cost/unit) – Yield*transp. cost/unit-mile * distance - Yield is defined as units per acre

Importance of Transportation Assume the following: Yield=10,000 gallons per acre Market price=3 EU per gallon Prod. Cost=1 EU per gallon Transp. Cost=.05 EU per gallon per mile Rent at the city center = 10,000(3-1)-10,000(.05*0) =20,000 EU Rent 5 miles away = 10,000(3-1)-10,000(.05*5) = 17,500 EU - Rent is the one year price

Importance of Transportation As you move further from the city center, the value of land goes down Depending on other economic opportunities, milk producers may be outbid at locations near the city center for land Rent Per Acre Distance from City Center The value will go down with distance from the city center in all directions – circles of land value Land use is also determined by the value of the land for alternative uses – in this example, beef production will occur from the city center out to the intersection of the beef production/milk production lines Beef Production Rent Per Acre Milk Production Distance from city center

Importance of Transportation Transportation expands the size of markets available to firms Transportation reduces the prices of goods to consumers, and increases the variety of goods available Transportation provides personal mobility for individuals Transportation expands the size of markets available to firms – firms can sell products in different parts of the Turkey., and in different parts of the world Transportation reduces the prices of goods to consumers because they are able to get goods from other locales and because firms are able to compete in broader markets Transportation provides access to work, church, shopping, social activities, and travel for individuals Transportation accounts for a large portion of Turkey. GDP, employs a lot of workers, accounts for a significant portion of final product costs

Importance of Transportation 7. Transportation accounts for a large portion of the Turkish economy 8. Transportation has an impact on the environment and consumption of energy