Question 5

Development of commuter towns around Cambridge means new houses will be

built to accommodate the residents who might work in Cambridge. The higher
number of residents in these towns will also increase the volume of traffic within
Cambridge. As additional traffic not only yields private cost (such as fuel, time
cost), it also yields additional costs, the most important of which are road
damage costs, accident externalities and congestion costs. This answer will
focus on evaluating the possible effects of levying a charge on developers and
imposing a cordon toll.

Levying a charge on developers is similar to a tax on the supply of properties,

with the size equal to the estimated external cost of congestion. Under tax
incidence principles, the relative burden on the consumers depends on how
easy it is for the consumer to switch out of consuming that good (i.e. the price
elasticity of demand) As one would expect that consumers will have relatively
price inelastic demand for housing, the major proportion of the levy will fall on
the consumers, with producers bearing part of the charge as well.

Ceteris Paribus, levying the charge on developers will only have a one off effect
in reducing the traffic of the commuters: after paying for the charge, residents
will still drive to Cambridge, which will not solve the congestion problems.
However, this charge might be able to reduce congestion costs via alternative
channels: for example, in an attempt to reduce the amount of levy, the
developers might be more likely to cooperate with nearby commuter towns and
Cambridge city to develop park and ride, and/or cooperate with public transport
companies to provide public transportation services to residents. These
schemes will encourage town residents to better utilise public transport,
consequently relieving the amount of traffic congestion.

Finally, the sizes and locations of these towns will depend on how developers
respond to this charge. The developers might decide the demand elasticity is
relatively high, and so developers might respond by developing smaller
commuter towns further away from Cambridge then before, so that the levy will
hopefully be smaller. On the other hand, if the developers attempt to lower the
levy charged, then they might decide to develop the properties further away
from Cambridge and develop a smaller town.

The Cordon Toll system is a fee/tax paid by road users when they enter the
central restricted areas in Cambridgethis system aims at relieving the traffic
congestion within the area. It is arguably a more efficient way of internalising
the externalities from traffic congestions, since the road users who generate the
congestion externalities are directly taxed. Compared to the levy on developers,
the incidence of the levy falls wholly on the residents. As developers do not bear
any part of the tax/charge to correct for congestion externalities, their choice of
location for the town and the size of the development will be independent of the
charge, and it is likely they will pursue development as near as possible to
Cambridge and as large as possible. Moreover, they also have little incentive in
partnering with commuter towns and public transport.
Therefore, the use of Cordon Toll is arguably a more efficient way of reducing
congestions. However, due to equity concerns and its potential unpopularity,
policy makers might need to resort to a levy on developers for their properties.
Of course, there is ambiguity with respect to the impact of the levy due to
uncertainty on how developers might react to these schemes.
Question 6
Summary:
Road is a valuable and scarce resource, and road-users should pay up to
the marginal social cost of using the road network. This requires designing
a system that charge them the MSC
Step 1: identifying the marginal social cost of allowing a particular vehicle
to make a particular trip, which can be decomposed into:
o Private cost: direct cost of using the vehicle
o External cost: increased congestions leading to delays; pollution
Step 2: determine whether road-users should pay additional taxes above
road-use costs
Relevant Principles of Taxation:
o If production efficiency is feasible, and if the resulting private profits
are either negligible or can be taxed away (satisfied if the economy
was competitive and externalities could be corrected or
internalised), then the Diamond-Mirrlees production efficiency
should be maintained, such that any distortionary taxes should fall
on the final consumers.
o Relevance to road pricing: road users can be divided into those who
transport freight (intermediate service used in production), and
those who drive their own cars/transport passengers for final
consumption
Freight transport users should pay the road-use costs to
correct externalities/ pay for marginal costs of maintenance.
Additional taxes can be set using principles that guide the
design of other indirect tax
Step 3: examine how far these methods have repercussions outside the
transport sector, and where these occur, how to take them into account.

Main costs to road use

Vehicles impose 4 main costs on the rest of the societyaccident
externalities, environmental pollution, road damage, and congestion.
o Accident externalities: arise whenever extra vehicles on the road
increase the probability that other road-users will be involved in an
accident. These accident externalities could be as large as all other
externality costs altogether (Newbery, 1988a). 2 important
componentsvaluation of life (and the traffic levels (determined
from a properly estimated cross section analysis)
o Road damage costs: costs borne by the highway authority of
repairing roads damaged by the passage of vehicles, and the extra
vehicle operating costs caused by this road damage. Valuation:
damage costs proportional to its damaging power. In Britain,
costs=average annual costs of maintaining the road network in a
stable state, multiplied by fraction of the road deterioration caused
by vehicles.
o Congestion costs: arise because additional vehicles reduce the
speed of other vehicles, and hence increasing their journey time.
Valuation:
 b
The travel cost per km of a representative vehicle is: c=a+
v
If additional vehicle is added to the flow, the total social cost is
dC dc
increased by =c+q . , where the first term is the private
dq dq
cost borne by the vehicle, and the second is the marginal
externality cost borne by other road users.
The next step is to establish the speed-flow relationship,
v =v (q ) which is estimated to be of the form v = q

Road Pricing Charge

Ideally, vehicles should be charged for the road-use cost of each trip, so
that only cost-justified trips are undertaken. Road damage costs are not
too difficult to charge (largely a function of the type of vehicle and the
extent they are loaded)
The more difficult task is to charge for congestion, which varies depending
on the level of traffic, which in turn varies across roads and with time of
the day
One direct way of charging for congestion is to use an electronic number
plate and charge an amount specific to the road and time of day.
o However, as the policy experiment in Hong Kong shows, this may
face objection due to the lack of public understanding (not knowing
the current system will replace the existing one)
Until road pricing is introduced, alternative method is necessary. One
solution is to use second-best solutions such as selling area licenses, fuel
taxes and/or vehicle purchase tax. However, these policies do little to
encourage them to drive on less congested roads or at less busy times of
the day.

Pricing public transport

Difficulties with subsidising public transport:
o Hard to compute the second-best public transport subsidies given
the great variation of congestion costs by time of day/location
o Subsidies have to be financed by taxes which have distortionary
costs
An alternative approach would be to improve the public transport, possibly
at the expense of the former. For example, giving priority to public
transport at traffic lights, banning private cars from congested streets
during the working day