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Summary Transport Economics & Management
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LECTURE 1 – Demand (CH. 3)1.1 Definitions
Demand: # consumers with a willingness-to-pay for a certain product
Effective demand (in economics): # consumers with a willingness-to-buy a product at a given price
Derived demand (in transport): “where” the products are wanted, f.i.: travel distance’s derived demand
is petrol, majority of demand for passengers transport is derived
The law of demand states that as the price ↑, the demand ↓
Two explanations for law of demand existence:
1) Income effect: if the prices increases the purchasing power of
the consumers will decrease (assumed in no income change)
2) Substitution effect: if the price increases the consumer is likely to look for substitutes fulfilling
same needs (cheaper alternative)
Exception to law of demand: “conspicuous consumption”, people buy certain products for a higher
price than they should due to the status they “obtain” from it
Assumptions of consumer’s demand
* rational behavior/self-interest
* utility-level (U) maximization of output
à indifference curve shows utility level for changing levels of output (Q)
· indifference curve: line of factor combinations holding equal utility level
· slope of indifference curve (=slope budget curve): change Q2/change Q1
* cost minimization (Y: limit by budget constraint)
à budget curve shows maximum tolerated price (P) for changing levels of output (Q)
· Y=(p1*Q1)+(p2*Q2)
· Y for Q2=(Y-p1*Q1)/p2, Y for Q1=(Y-p2*Q2)/p1
· slope of budget curve (=slope indifference curve): change Q2/change Q1
Inverse demand = the price a consumer is willing-to-pay for a demanded quantity of output, so
maximum price a firm can charge for a maximized utility level of output quantity
> inverse demand function: P1=(p2*ΔQ2)/Q1
> linear inverse demand function: P=(a/b)-(1/b*Q), in which a/b is price(Q=0)
1.2 Determinants of demand
The most important determinant of demand for product = its price, others:
• The price of substitutes (also availability/quality)
• The price of complementary products (also availability/quality)
• Income (changes)
• Population (changes)
• Popularity/image
• Speed
• Reliability / security (risks)
• Bureaucracy (paperwork/administration for different modes of transport)
,Demand can shift in two ways
- decrease: shifting inwards
- increase: shifting outwards (graph)
1.3 Elasticity of demand
Elasticity of demand: represents the responsiveness of demand to a change in a factor (f.i. price),
measured in percentages (importance of a certain factor)
Elasticity = % change in factor A
% change in factor B
Price elasticity of demand (PED)= % change in output Q = (Qnew-Q)/Q = ΔQ/Q = ΔQ * P
% change in price (Pnew-P)/P ΔP/P ΔP Q
Elasticity assumes negative correlation due to law of demand (price ↑, the demand ↓)
* inelastic (equal) demand: between -1/0
* elastic (unequal) demand: >-1
à the larger the coefficient, the larger its importance (unimportance at ‘0’)
Types of elasticity
· arc-elasticity: measured over a substantial range of prices (output change) > ((ΔQ/Q)/(ΔP/P))
· point-elasticity: measured at a specific point (infinitesimal price change) > (𝜕Q/𝜕P)*(P/Q)
Factors determining price elasticity of product
1. Proportion of consumer expenditure: the lower the proportion of consumer expenditure, the
more price inelastic (person spending 100$ on jeans, cares less on price increase of 1,5$)
2. Addictiveness: the higher the addiction, the more price inelastic (cigarettes)
3. Level of necessity: the more the necessity, the more price inelastic (schoolbooks)
4. The time scale: price change on short term more price inelastic, than price change on long
term (rail transport increase price, consumers need time to seek alternative transport nodes)
5. The closeness of substitutes: the lower the closeness, the more price inelastic (not replaceable)
1.4 Market price
Market place: trade-zone between suppliers/consumers (supply-demand)
Market (clearing) price: price at which equilibrium (balance) is reached between
quantity demanded versus quantity supplied, so no underage/overage items
1.5 Market welfare
Welfare (value) determined by the consumer and producer control/create supreme power; for
consumers in market equilibrium, the price represents the price they are willing to pay for one extra
unit (own judgment of an item’s value)
Market welfare = consumer’s surplus + producer’s surplus
Consumer’s surplus: the benefits consumer’s derive from additional good (maximum price consumer
willing to pay - market price equilibrium), representing extra satisfaction of product
, Producer’s surplus: the benefits producer’s derive from additional good (market price equilibrium –
cost or producing equilibrium quantity), representing extra satisfaction of product
> under the indifference curve to guarantee consumer maximization of utility
Summary on estimating demand - need information
on demand parameters (elasticity) - demand quantity
(Q) = function of price (P), income (Y) & trend (T) >
Q=α*P+β*Y+γ*T - assumes a causal
relation between variables (P, Y, T)
LECTURE 2 – Cost Functions (CH. 4)
2.1 Definitions
There are four factors are necessary for a production to occur
• Land: raw materials
• Labor: workers
• Capital: man-made resources - machines, computer systems, financial capital
• Entrepreneurship: risk-taking, ownership, organization of other factors
Cobb-Douglas function: production of output quantity (Q) = function of labor (L) and capital (K)
- labor (L) at price w
- capital (K) at price r
Cost function: formula to predict cost associated with certain output quantity
> determine minimal production cost based on Cobb-Douglas function
> production-cost function: minimal cost of producing Q for input prices, with optimal levels of K, L
> cost function C=C(Q,r,k) with (C)=w*L+r*K in a graph with equilibrium of isoquant / isocost
· isoquant: same level Q produced with less inputs (=indifference curve)
· isocost: combination of inputs with same total costs (=budget curve)
Goals of cost function (C(Q,w,r))
= cost minimization (rational behavior/self-interest)
= urge to increase Q
= inability to lower labor (w) and capital price (r)
à so: C(Q,x*w,x*r)=x*C(Q,w,r)
Two other important definitions of production are “long term” & “short term”
- short term: period of time in which at least one of the production factors is realized
- long term: period of time in which all production factors are realized
2.2 Classification of costs according to their nature
A cost is something that a producer has to pay in order to remain in operation; 3 types of costs
1: Fixed costs (FC) Costs that are the same for each level of output (capital)
2: Variable costs (VC) Costs that change when output-level changes (transport, fuel costs)
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