Transport economics and

management

Eric Pels

Demand
 This lecture

Introduction
Discussion of demand drivers
Demand analysis: basics
Elasticity of demand
Welfare
Purpose: Understand the theory behind demand for
transport services and welfare.
Why? Because as a manager in the logistics sector
you need to understand actions of consumers and
(transport) policy makers.
For the exam: Can you explain the concepts of inverse
demand, total surplus and elasticity?
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TEM
 The economics of demand
In a company you make decisions
Location, investments etc.
Business case
Profits, loss, sales etc.
Decision making tools (OR), regression analysis etc.

Governments make decisions

E.g.: Why is one route better than another for a new rail freight
line or a new road?
Cost-benefit analysis
Construction, operating and maintenance cost; benefits: consumer &
producer surplus, external effects, indirect effects
Demand analysis: Conceptual framework to describe preferences
Demand; willingness-to-pay (determines revenues)
Each user (rail freight company, cargo owner) has its own set of preferences

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 The economics of demand

Assumptions: consumer
is rational
is self interested
maximizes utility U

Consumer makes a choice to buy good Q1 or Q2

(e.g. options on your car), given his/her budget
constraint: Y=p1Q1+p2Q2

Indifference curve: combinations of X1 or X2 that

yield the same utility level
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 The economics of demand
Things that
make your car
look good

Q2 Indifference curve (higher level of U)

Indifference curve
(slope = Q2/ Q1, amount of Q2 we
exchange for a unit of Q1), given level
of U

Budget constraint:
Q2=(Y-p1*Q1)/p2
Q1
Indifference curve (lower level of U)
Things that make
your car safe 5
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 The economics of demand
I start in point A
Reducing Q2 with AB
means I need BC of Q2 to
maintain the same utility
Q2 level
A But reducing Q2 with AB
means I have room in my
budget to acquire more
D than BC of Q2
B C
Reducing Q2 with AB
means I have the budget
to acquire BD of Q2 and
reach a higher utility level

Q1

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 The economics of demand; graphical
representation
Budget constraint: Drawn (for simplicity) as linear
Q2=(Y-p1*Q1)/p2 curve: P=a/b-1/b*Q
At each point we have the
Q2 p1 combination of p1 and Q1 at
which utility is maximized!

Q1 Q1

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 The economics of demand

Interpretation of (inverse) demand curve:

In the optimum (point D): slope budget curve = slope
indifference curve; p1/p2 = Q2/ Q1
Inverse demand: p1 = p2*Q2/ Q1
Maximum price we are willing to pay (and a company can
charge) so that our utility is still maximized
The benefit we derive from Q1 (expressed in monetary
terms): often used as measure of welfare (as used in cost-
benefit analysis)
Measures how much (value) of Q2 is given up for more Q1, given
that utility is maximized

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 What determines demand?

Price of substitutes Standard variables,

Price of complementary goods not necessarily
controlled by you as
Income manager
Population Determinants of
Bureaucracy transport demand also
not under control by
Security manager
Popularity/image Determinants of
Speed transport under control
by manager: part of
Reliability planning process

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 Elasticity of demand

Elasticity:
Responsiveness of demand to a change in a factor (e.g.
price), measured in percentages.
% change in output
price elasticity of demand =
% change in price

X = change in variable X: X = Xnew-X

% change in price = (Pnew-P)/P = P/P
% change in output = (Qnew-Q)/Q = Q/Q
Q/Q Q P
price elasticity of demand = =
P/P P Q
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 Elasticity of demand

Point-elasticity: measured in a point (infinitesimal

price change ).
The elasticity at the current level of demand

Price elasticity then is:

For instance, a price elasticity of -1.15 means that

demand decreases by 1.15% if the price increases by
1 %.
Inelastic demand: -1 < price elasticity < 0
Elastic demand: price elasticity < -1
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 Elasticity of demand: Point-elasticity

P=a/b-1/b*Q
P Ped=? Q=a-b*P
Elasticity =

Ped=-b*a/(2b)/(a/2)=-1 (Q/P)*P/Q

a/(2b)
Ped=?
Note: the price
elasticity is not the
slope of the demand
0 a/2 a Q curve

Important graph; returns a few times during this course

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Elasticity of demand: Point-elasticity

This is important when

we discuss monopoly
P and regulation

elastic
Ped=-1

inelastic

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 Determinants of elasticities

Price elasticity influenced by:

Proportion of consumer expenditure

Addictiveness

Level of necessity

Time scale

Availability of substitutes

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 Welfare

Consumers
Inverse demand curve gives willingness-to-pay
Benefit consumer(s) derive(s) from additional good
Area under inverse demand curve measures total benefit or total
surplus

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 Welfare

P Inverse demand (marginal benefit)

Total benefit (surplus):

Area under inverse demand
(at P=0)

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 Welfare

P Supply

Equilibrium price Total surplus:

At equilibrium price

Equilibrium quantity Q

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 Welfare

Consumer surplus
When supply = Marginal
P cost (next lecture)

Equilibrium price Producer surplus

Cost of producing eq
quantity
Q
Equilibrium quantity

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 Estimating demand

Need for info on demand parameters

Elasticities
Q=f(P, Y, t)
Demand (Q) is a function of price P, income Y and time trend t.
Q=*P+*Y+*t or lnQ=*lnP+*lnY+*t
Assumes a causal relation between variables
P, Y and t cause Q
data on prices, demand, income and other characteristics needed
Part of tutorial
time series
OLS

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 Applications

E.g. at Schiphol.
Policy question:
What is potential demand (passengers and
freight) on routes not yet served?
Method:
Estimate demand for existing origin destination
pairs.
If you know the demand drivers for OD-pairs not
yet served you can predict demand.

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 Summary

Important concepts for today:

Preferences and choice
Inverse demand
Elasticity
Total surplus (also called total benefit)

Next time: cost functions

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