Economics for Transport Manager - Essay Example

?Economics for transport manager Transport is a significant sector of the economy. The paper therefore discusses the economics of the transport sector applicable to business perspectives. Firstly, the paper focuses on mechanisms of setting standard price as are used in this sector. Identifying the price mechanisms and the importance of a proper market structure to the management are the subsequent topics of discussion. Competition has been identified as essential for efficient functioning of a market. Truly being applicable for the transport sector of the economy, the next topic of discussion of the paper is the importance of competitive laws and the effect of improperly designed competitive laws on economic functioning with its applicability to the transport sector. Transportation holds a significant position in the consumer basket and increase in its cost affects the consumer price index. Moreover transportation acts as a tool in maintaining stability of the economy through proper distribution of goods and services. Improper functioning of the sector may lead to the increase in price of products through the increase in transportation costs. Thus the importance of transportation in the economy as well as in the life of common people is the main focus of this paper. Introduction Transport services are required in an economy in order to gain access to goods and services, education, employment and leisure activities. Almost each and every transaction in modern economy centers rounds the system of transport. Improved transport sector contributes to economic growth. Badly developed transport and problems in the proper functioning of the sector contribute to economic instability. Transport sector is experiencing changes recently with new innovations and enhanced technology. (Cowie, 2009, p. 2) For efficient management of the functioning of this vital sector of the economy there is the need for understanding the economics of transportation along with the features of basic economics. The complication of transport economics arises because of the peculiarities in different modes of transport. (Cool, 1998) Transport economics considers the pricing mechanism of the sector along with the identification of a proper market structure. Assurance of proper competition in the sector increases the efficient functioning of the sector. Besides the use of the sector in production purposes, it has great importance amongst the consumer class of the society. Transportation cost holds a significant amount in consumer’s budget. Moreover transportation costs determine the price of products with increase in the former, contributing to simultaneous increase in the later. Thus the main aim of this paper is to discuss the different aspects of transport economics along with identifying the importance of the sector in every economic transaction. Pricing in the transport sector of the economy depends on different and continuously changing factors. The factors that have been identified are the type of the transport, the different types of industry and the countries and towns in which the transport sector is functioning. Moreover the pricing mechanism of the private transport industry differs from that of public transport. Thus there arises the need of discussing the two different price mechanisms of average cost pricing and marginal cost pricing for the transport industry. (Jansson & Martinsson, 2003, p6) Difference between average cost pricing of a monopolist and marginal cost pricing Average cost pricing is referred as the procedure of charging price by a monopoly. If P is the price of the monopolist and AC is the average cost then the approach of average cost pricing of monopolist is accomplished where P = AC. In case of average cost pricing the firm enjoys zero profit. In transportation, setting price equal to average costs means the provider will offer the service when the value of providing the service is at least equal to the average cost of the same. (Haworth, n.d) P A AC P=AC MC D O MR Q (Haworth n.d) In this diagram price is measured in the vertical axis and quantity in the horizontal axis. The two downward sloping curves are the demand curve or the average revenue and the marginal revenue curve of the firm. The average cost curve of the monopoly to some extent represents a rectangular hyperbola. According to the average cost pricing approach the firm will set the price where the average revenue curve intersects the demand curve of the firm that is at the point A in the diagram. In case of the marginal cost pricing the firm sets the price of its product equal to the marginal cost of the firm. If P is the price of the product, and MC is the marginal cost then according to the pricing theory P=MC. According to the marginal cost pricing an additional trip will be made by an individual if the additional value of the service they are providing is at least equal to the additional cost incurred in providing the service. (Haworth, n.d; Akiva, 2008) P AC P=MC A MC O D MR Q (Haworth n.d) Thus in case of marginal cost pricing, price is set at the point of the intersection of the demand curve and the marginal cost curve, at the point A. The firm setting its price in this approach suffers a loss as it cannot cover the average cost of production and hence is forced to exit the industry in the long run. (Haworth, n.d) The approach of average cost pricing ensures zero profit for the monopolist but a socially optimum solution is not ensured as there is the occurrence of dead weight loss in this pricing method. Dead Weight Loss occurs because price remains greater than the marginal cost of the firm even though there is zero profit. Since average cost curve always lies above the marginal cost curve along its falling arm the socially efficient outcome is not reached. Pricing should be optimal so as to increase the efficiency of the economy. Transportation pricing is no exception to that. The provision of the transportation services is also required to be subjected to optimal pricing so as to maximize the benefits of the consumers and minimize the distortions of allocations. The public transportation services are in need of being priced using marginal cost pricing along with providing lump sum payments to the needy population of the society so as to ensure social well being. The private transportation sector in general use average cost pricing as their motive is profit maximization, more than social welfare. (Akiva, 2008) Pricing in transport industries also needs to consider the measures for reducing pollution and incidents of traffic congestions. (Monopoly, n.d; Haworth, n.d; Batarce & Ivaldi, 2010) Importance of identification of market structure in transport and logistics business management After discussion on the price mechanism of the sector there is the need of identifying a proper market structure. Identification of the proper market structure in the transport and logistics sector of the economy is important in its own rights in understanding the demand and the supply side of the sector as well as for the understanding of the basis of suitable governmental policies for the betterment of the transport sector of the economy. There is also the need of identifying a market that is completely free and competitive for provision of transport services. Moreover many of the problems arising in the transport and logistics sector of the economy are because of the ill and improper functioning of the market. Since the rules of determination of the price of the service and the quantity to be supplied are different in different market structures, there is the need of proper identification of the market structure prevailing in the sector for efficient management of the business. (Cowie, 2009, pp. 35-36, 55) The existence of firm heterogeneity has been identified as a determinant of the market structure along with the entry and exit of individual airlines in the Airline industry of the United States. The procedures of entry and exit of firms in the industry are different for different market structure and affects the profit levels of the competing firms of the industry. Entry of firms in the airline industry has inverse relationship with the profit of the total airline industry. Moreover the effect of competition between the large airlines are not similar to the effect of the low cost careers, thus competitive market structure also differs among firms in the airline industry (Ciliberto & Tamer, 2009, pp. 1791, 1806). According to the market structure and conduct of firms the structure performance hypothesis determines an inverse relationship between the degree of market competition and the degree of market concentration. Irrespective of the efficiency of the firms, higher profits are earned by firms operating in industries that are more concentrated. This is equally true also for the transport industry. Thus identification of a proper market structure is necessary for the business management of the sector. (Edwards, Allen & Shaik, 2006, p. 2) Poorly designed competition laws harm competition Healthy competition is important in every sectors of the economy including the transport sector. Fostering and enhancing competition for the purpose of accelerating economic growth is the main objective of the competition laws or policies. The competition laws give importance to innovations and efficiencies of the market. The efficiency can be reached through the offering of better products at low prices to the consumers. Thus the consumers are benefited which helps in the maximization of the welfare of the society. Competition laws focus on the prohibition of agreements of anti competition along with practices that affect free trade. The regulation of merger and acquisitions is also a part of the objectives of competitive laws. Divergence in the proper application and enforcement of the competitive laws along with the practice of laws that are poorly designed leads to decrease in the effectiveness of the laws in encouraging competition. Study reveals a strong correlation between effective and well designed competitive laws and economic expansion. Improper implementation of competitive policies along with poorly designed laws has various controversial aspects that outweigh the social and economic benefits of competition. Competition laws are central element of economic reform. Proper implementation of the competition laws in the transport sector helps in providing the fuel for the proper functioning of the transport chain which is vital for the overall economy. Ill designed competition laws on the other hand works in putting a brake on the solutions to the problems of transportation in an economy. The laws undertaken by the National transport Commission of Australia contains within it identified steps for the improvement of the performance and operational efficiency of the supply chain of the national freight corporation of the country. The competition laws undertaken focus on coordination among the different participants of supply chain and arrangements of improved information sharing. However the government has the fear that improper implementation of the act may result in breaching with the trade practices act prevailing in the country which may result in companies being engaged in cartel offenses. (Samuel, 2010) If price liberalization is accompanied by ill designed laws then it will result in reducing the social benefits as monopolistic competition will be unchecked. Unchecked monopolistic competition will have effect on the prevailing price and hence forcing the small and the marginal firms out of the market. Thus transparent competition will not subsist. There is the need of proper competitive laws to accompany import competition and market liberalization. Improper design of these laws leads to the absence of safeguard resulting in the engagement of the foreign firms in anticompetitive practices. Poor design of the competitive laws results in the foreign firms abuse the dominant position in the market. Proper and effective competitive laws encourage market conduct of firms through the ban on anti competitive agreements. This also helps in enhancing public benefits. Thus to ensure healthy competition there is the prerequisite of the competitive laws prevalent in an economy to be properly implemented and well designed. (Mehra, n.d) Competition is always important as it increases the efficiency of the industries. Enjoying monopoly for a considerable period of time affects the efficiency and often results in forcing the firm towards situations of economic crisis. The perfect example of large and inefficient monopoly is Transnet Limited, a transport monopoly of South Africa. Inefficient competition in the sector of the country made the executives of the company lethargic and the company is on the verge of experiencing severe economic crisis. Thus there was the need of proper and efficient competitive laws in the sector so as to ensure competition and hence efficiency of the industry (Srikanth & Guru Dutt, n.d). Fuel cost increase affects the Consumer Price Index Transportation is an important aspect of our everyday life and holds essential position in the consumer basket. The consumer price index is the data on changes in the prices of representative basket of goods and services paid by the consumers. The experience of the relevant average households of a country on the market baskets and the pricing procedures of a country gets reflected by the consumer price index. It is the national index of the prices of consumer products. More than two hundred products categorized in eight major categories constitute the index. Transportation is one of the major eight categories. Rises in the prices of any included commodities apply an upward pressure on the overall value of the index (Bureau of Labor statistics, 2010). Fuel price and fuel costs are calculated as a part of the index and hence the rises in the fuel costs imply an increase in the Consumer Price Index. Thus the surge in the fuel costs pushes the value of the index. This increased effect on the consumer price index can be proved through various real life examples. Increase in the fuel prices and energy costs impacted on an increase in the consumer price index of Europe to about 3.4% in the year 2010, well above the forecasted rate of 3%. Surging costs of fuel pushed up the price level resulting in inflation in the economy. This high inflation rate impacted on the increased value of the Consumer Price Index. Increase in fuel costs resulted in annual increase of the transport component of the index. Excluding the volatile components of energy and some other consumer items the core rate of the consumer price index for Europe was found to increase only by 1 percent from the previous financial year to the new financial year starting from March of 2010 (Allen, 2010). The statistical data of Canada for the month of April in the year 2011 reveals that with the advancement of the transportation index of the country to 1 percent results in the increase of the shelter index by 0.5 percent from the previous month’s increase of only 0.1 percent. Considering the annual change of the various components of the index it had been revealed that the main factor contributing to the rise in the value of the index is the increase in the transportation cost of the country (Statistics Canada, 2011). Thus it can be said from all these real life studies that the increase in the costs of fuel and hence transportation pushes the consumer price index increasing its value. Change in the way of calculating Consumer Price Index for considering the increased use of ethanol The increased use of petrol and other fuels for transportation results in the emission of green house gas leading to an increase in temperature of the earth’s surface and atmosphere. Thus scientists are focusing on the increased use of bio-diesel and ethanol which are environment friendly. (The Environment, n.d) However ethanol use has been proved to be less efficient resulting in increase in the fuel costs. This increase in the fuel costs pushes up the consumer price index as the costs of the transportation segment of the index increases. Thus the increased value of the consumer price index reflects the increased cost of living of the people without considering the benefits of the use of the new product. Thus change in the quality of products and increase in social benefits from use of the product is in the need of being incorporated in the calculation of the index. The progress of the economy with substitution of products of the consumer basket needs to be considered while calculating the consumer price index (Schultze, 2003, p.11) Moreover the non market goods are not reflected in the index. The price of clean air that can result from the use of ethanol in petrol is not included in the calculation of the index which is a drawback. Thus there is the need of incorporating these issues in the construction of the index so as to measure the negative inflation and betterment of the quality of living of individuals. (Environmental and urban economics, 2011) Social and economic effect of rising prices Increased fuel costs along with increasing the value of the index also affect the social and economic aspects of an economy. The social and the economic effects of the rising prices can be studied considering the experience of Iraq. The failures of the country of Iraq in political aspects lead to the increased price of the consumer goods. Every staple food of the economy experienced a sharp increase in price. Fuel and prices of electricity along with staples also experienced about 270 percent increase over the prices prevalent in the previous years. With the quadrupling of the price of tea and doubling of the price of egg, price of every items of the consumer basket went beyond the reach of the people especially the low income groups of the country. Every citizens of the country suffered miserably as the commodities of their regular need became too expensive. The government of the country was being blamed by the people because of the shortfall of security and steadiness in the economy. Corruption and violence in the mid of the government control of the country resulted in the increase in price of regular use commodities creating the life of the people of the country miserable. The increase in the price of fuels increased the transportation costs of raw materials. With the increase in transportation cost the cost of production of the commodities increased and hence multiplies the price of those. The worst social impact of the price rise was increased corruption and incidence of black markets in the economy of the country. Increased fuel prices created increased tensions in the country with increased reports of social riot. The continuous rise in the prices of bare necessities contributed to 70 percent increase in the inflation rate of the country in a single year. There occurred no change in the wage rate of the country and wages became flat. The banks of the country barely functioned. The inflation rate of the country was on a trend of a continuous increase. The distribution system of the country became unstable. The most visible example of the dysfunction of the economy was the fuel of the country. Within a few months the price of fuel increased from 4 cents a gallon to as high as 67 cents. The unemployment rate of the country increased to about 60 percent. Absence of employment opportunities along with increased prices characterized the then situation of the economy of the country. Efforts on the part of the government in stabilizing the economy through the process of increased interest rate for business and mortgages became invalid as people were not taking loans in the mid of the crisis in the economy of the country. (Cave, 2011) Impact of government policy of tightening money supply in the economy Restricting monetary flow in the economy is generally viewed as a process of controlling the inflation rate. However in situations of coexistence of high inflation and high unemployment rate in the economy, restricted monetary policy on the part of the government may not prove to be beneficial as it may have retarding effect on the economy through further reduction in the employment opportunities. Restricted monetary policy may be useful if money is the only factor contributing to the high inflation and unemployment in the economy. (Causes, 2010) For the economy of Iraq, The government of the country might look for policies influencing the supply side of the economy. If the supply of fuel in the country increased then automatically price of the product would have experience a decrease. With the decrease in fuel costs, there would have been an automatic reduction in the cost of transportation. Reduced transport costs would contribute to the reduction in the cost of production of different commodities making the price of those cheaper. Thus there was the need on the part of the government to ensure a proper distribution system in the economy rather than restricted monetary policy. Proper distribution system would have helped the economy in eliminating the black markets ensuring proper supply of required raw materials for production of commodities at a cheaper rate. Conclusion Thus to conclude it can be said that transportation is a sector that has huge importance in every aspects of economy. Economic stability and instability to a certain extent is determined by the proper functioning of the sector and it holds an important place in the daily life of common people. Apart from market structure, fuel costs are an important determinant of business decisions. This is because the pricing in the transport sector undergoes high rates of fluctuation owing to fuel price behavior. The fuel price also affects the overall price level and therefore calls for some policy interventions. However monetary interventions do not always bear fruit since the supply side constraints need to be taken care of. The costs of transport which is in turn dependant on fuel costs to a large extent have a cascading impact on all other products and services as can be witnessed in case of Iraq. References 1. Akiva, M. B. (2008). Pricing of Transport services, Massachusetts Institute of Technology, available at http://ocw.mit.edu/courses/civil-and-environmental-engineering/1-201j-transportation-systems-analysis-demand-and-economics-fall-2008/lecture-notes/MIT1_201JF08_lec12.pdf (accessed on 10th June, 2011) 2. Allen, K. (2010). Inflation: surging fuel costs push CPI to 3.4%, Guardian, available at http://www.guardian.co.uk/business/2010/apr/20/inflation-rises-march (accessed on 9th June, 2011) 3. Batarce, M. & M. Ivaldi, (2010), Nonlinear pricing in transportation, Toulouse School of Economics available at http://idei.fr/doc/wp/2011/ivaldi_batarce.pdf(accessed on 9th June, 2011) 4. Bureau of Labor Statistics, (2010), Consumer Price Index, United States Department of Labor, available at http://www.bls.gov/cpi/cpifaq.htm#Question_1(accessed on 9th June, 2011) 5. Causes, (2010), Against Inflation, available at http://www.againstinflation.com/index.php?id=139 (accessed on 9th June, 2011) 6. Cave, D. (2011), Weary Iraqis face New Foe: Rising Prices, S1.M.Economics for Transport Managers 7. Ciliberto, F. & E. Tamer, (2009). Market Structure and multiple equilibria in Airline markets, Econometrica, Vol 77, No 6, pp1791-1828, available at http://people.virginia.edu/~fc3p/papers/ecta5368.pdf (accessed on 10th June, 2011) 8. Cool, T. (1998). Transport Economics for operation management, International School of Economics, available at http://www.dataweb.nl/~cool/TELecture/Lecture.html(accessed on 10th June, 2011) 9. Cowie, J. (2009). The economics of transport, London: Taylor & Francis 10. Edwards, S. Allen, A. & S. Shaik, (2006), Market Structure Conduct Performance (SCP) Hypothesis 11. Revisited using Stochastic Frontier Efficiency Analysis (2005), American Agricultural Economics Association, available at http://ageconsearch.umn.edu/bitstream/21350/1/sp06ed01.pdf (accessed on 10th June, 2011) 12. Environmental and urban economics, (2011), CPI Bias Revisited, available at http://greeneconomics.blogspot.com/2011/01/cpi-bias-revisited.html (accessed on 9th June, 2011) 13. Haworth, B, (n.d.), Natural Monopolies and Pricing Policy, Economics 201, available at http://www.econpage.com/201/handouts/natmonop.html(accessed on 9th June, 2011) 14. Jansson, P & M, Martinsson, (2003), Service Producer Price index for other transport agencies, TPI development report no 8, available at http://www.scb.se/statistik/PR/PR0801/report8.pdf (accessed on 10th June, 2011) 15. Mehra, M, (n.d), Competition Law and Policy for sustained Prosperity, International Academy of Law 16. Monopoly, (n.d), Sky View, available at skyview.vansd.org/REmerson/AP%20Economics/.../ch15.doc (accessed on 9th June, 2011) 17. Samuel, G, (2010), How competition law supports transport and logistics solutions, Australian Logistics Council Forum, available at http://www.accc.gov.au/content/item.phtml?itemId=916863&nodeId=2a3afb3faf8da3cce01d782c701882c7&fn=How%20competition%20law%20supports%20transport%20and%20logistics%20solutions.pdf(accessed on 10th June, 2011) 18. Schultze, C. L.(2003). The consumer price index: conceptual issues and practical suggestions, Journal of economic perspectives, vol 17, no 1, pp 3-22, available at http://www.rau.ro/intranet/JEP/2003/1701/17010003.pdf (accessed on 9th June, 2011) 19. Statistics Canada, (2011), Latest release from the Consumer Price Index, available at http://www.statcan.gc.ca/subjects-sujets/cpi-ipc/cpi-ipc-eng.htm(accessed on 9th June, 2011) 20. Srikanth, G. & P. Guru Dutt, (n.d), Case Study: Transnet, ICFAI business school case development centre, available at http://www.aabschools.com/case_studies/549.html(accessed on 9th June, 2011) 21. The Environment, (n.d), Petrol News, available at http://www.petrolnews.co.uk/environment/(accessed on 9th June, 2011) Read More