ECONOMICS Johnson Hsu July 2014

Transport economics 1.Transport, transport trends and the economy 2.Market structure and competitive behavior in transport markets 3.Market failure and the role of interventionin transport market 4.Transport economics and government policy

Costs  The value of inputs

Fixed costs  Costs that are independent of output produced

Variable costs  Costs that are directly related to the level of output produced

Total cost  The total cost of production or provision of a service  Total cost = Fixed cost + Variable cost

Vehicle operating costs of 44-tonne articulated vehicle with average annual mileage of ￡ per annum Pence per mile Standing costs Vehicle excise duty1, Insurance3, depreciation13, , Running costs Fuel33, Tyres3, Maintenance10, , Total vehicle cost66, Cost of driver 30, Cost of vehicle and driver96, Business of vehicle and driver14, Total cost 110,

Average cost  The unit cost of production

Marginal cost  The change in total cost when one more unit of output is produced

Revenue  Receipts from sales

Total revenue  Quantity x price

Price taker  A firm in a competition market that has to accept the market price

Price maker  A firm that has control over the market price

Average revenue  Total avenue ÷ quantity

Marginal revenue  Addition to total revenue from one additional sale

What is the optimum point of production for short run? Ans: where the average cost is at its minimum point.

Short run  Time period when a firm is unable to change factors of production except for one, usually labour

Long run  Time period when all factor inputs can be changed

Minimum efficient scale  The lowest level of output where long-run average cost is minimised.

Economies of scale  The benefits gain through producing on a large scale

General sources of economies of scale  Technical economies  Purchasing economies  Managerial economies  Financial economies

The cause of diseconomies of scale are  Problems of communication  Problems of co-ordination  Problems of industrial relations

Purchasing economies  Reduced unit costs due to bulk buying of inputs into a business

Managerial economies  Saving in long-run average costs due to the specialisation of management

Financial economies  The cost saving that large firms may receive when borrowing money

Diseconomies of scale  Causes of an increase in long- run average costs beyond the point of minimum efficient scale

The objectives of a firm  Profit maximisation  The avoidance of risk  Long-term growth

External economies of scale  Falling long-run average costs that benefit all firms in an industry

Why firms may not operate exactly at the profit maximisation level of output?  It is difficult to identify the profit maximisation position, since firms are unlikely to know their marginal cost and marginal revenue. What is more likely is that they know their long-run average cost and will use this to determine prices by adding on a profit margin.  Large profits might attract the attention of government watchdogs, damage employee relations and attract new entrants into a market to alienate consumers

Profit satisficing  Where a firm makes a reasonable level of profit that satisfies its stakeholders without maximising profit

What are the reasons that a firm makes a reasonable level of profit that is sufficient to satisfy it shareholder or its owners while not maximising profits? Ans: 1.The firm’s manager may be unwilling to take unnecessary risks that are likely to occur with a profit maximisation objective. 2.Consistent with keeping stakeholders satisfied. 3.A firm has close business rivals.

Profit maximisation  The objective of firm that is achieved where marginal cost = marginal revenue

Sales maximisation  An objective that involves that maximisation of the volume of sales

Cross-subusidisation  A business practice where revenue from profitable activities is used to support loss-making ones

Break-even level  Where total revenue just covers total cost

Types of profit  Normal profit: the level of profit that keeps a firm in a particular activity  Supernormal profit: profit that is more than normal profit

Market structure  The characteristics of a market

Concentration ratio  The proportion of the total market shared between the nth largest firms

Two weakness when measuring the market concentration  It does not necessarily give a true picture of actual market shares.  It gives no indication of total market size.

The tools of barriers to entry into transport market  High set-up costs  Economies of scale  Legal barriers  Brand loyalty  Intimidation  Predatory pricing

Allocative efficiency  Where price is equal to marginal cost

Productive efficiency  Using the least possible amount of scarce resources to produce the maximum output

Natural monopoly  Where a monopolist has overwhelming cost advantage

Dynamic efficiency  Where unit costs are lowered over time

Contestable market  A set of conditions where there is always the threat of new firms being able to enter a market

Price discrimination  Where a monopolist charges different prices for the same product in different markets

What is important in transport market where there is a peaked demand? Ans:Time.

Monopolistic competition  A market structure with many firms producing a differentiated product and where there are few barriers to entry and exit

Product differentiation  Where there are minor variations in the types of products on offer

The characteristics of monopolistic competition  Product differentiation  Firms are price makers, as in a monopoly.  There are a large number of firms in the market but none is relatively large in terms of the overall market size.  There are only low barriers to entry, making it easy for firms to enter this market; if supernormal profit is being earned, then this acts as a signal for new firms to enter. The cost of exit is also low, with firms able to recoup their capital expenditure.

Deadweight loss  Loss to society of the firm producing where price exceeds marginal cost

Excess capacity  A consequence of firms producing at above the minimum point on the averge cost curve

Non-price competition  Competition between firms on the basis of, for example, branding, customer service, location, range of product, advertising

Interdependent  Where the actions of one firm provoke counter-action by others

Characteristics for oligopoly  High barriers to entry  Price rigidity due to risk and uncertainties associated with price competition  Non-price competition in order to gain market share  Profit maximisation may not be the firm objective

Oligopolists behave  Kinked demand  indicative of price rigidity in oligopoly  Game theory  a means of modelling the behavior of firms

An oligopoly game matrix A’s price ￡1￡1￡1￡190p B’s pric e ￡1￡1￡1￡1 ￡ 2m each ￡ 1mB ￡ 2.2m A 90p ￡ 2.2m B ￡ 1m A ￡ 1.5m each

Collusion  Where firms tacitly or otherwise agree to not compete on prices, service provision and other matters that might adversely affect mutual well-being

Collusion example  A price agreement or output agreement designed to restrict competition, possibly to scare off new firms looking to enter the market  Price leadership, where when one firm, usually the market leader, increases it price and other follows

A market is perfectly contestable where  There is a pool of potential entrants into the market.  Entry and exit are costless.  All firms are subject to the same regulations and state of technology.  Mechanisms are in place to prohibit responsive or entry limit pricing, as existing firms have lower costs than potential entrants  Incumbent firms are vulnerable to ‘hit-to-run’ competition.

Third package  Open access, whereby EU airlines can establish themselves in any other member state and operate services with no capacity restrictions.  Airlines are permitted to fix their own fares and cargo rate subject to predatory pricing safeguards.  Common criteria have to be applied for granting operators’ licences.

Franchising  The outcome of a competitive system to bid for the provision of services