Economics 465/565 Transportation Economics-Lecture Notes #2

 

I.  Introduction: Modal splits in transportation over time

 

            A. Freight transportation:

 

                        1) By tonmiles: rail dominates although rail's share has declined from 61.3% of total tonmiles in 1940 to 37% in 1988.  Truck's share has risen from 10% in 1940 to 25.2% in 1988.  Pipelines have increased their share of freight tonmiles from 9.5% in 1940 to 21.9% in 1988, and water's share has declined some from 19.1% to 15.5% between 1940 and 1988.  Air transport only accounts for a small share of freight tonmiles.

 

                        2) By Expenditure: In 1960, rail accounted for 19.6% of freight expenditures while truck accounted for 70.1%; in 1980 the percentages were 13.2% and 74.1%, and in 1988, 9.8% and 77.8%, respectively.  Air transport's share of expenditure has risen from .8% in 1960 to 3% in 1980.  Note that air's 3% of expenditures on freight is much greater than its .32% of tonmiles.  Why?

 

Also note, pipelines are the third large carrier of freight tonmiles (21.9%0, but only account for 2.7% of freight revenue.

 

Discuss heavy, bulk commodities that have low values.

 

            B. Passenger transportation

 

                        1. Commercial passenger: air went from 3.3% in 1940 to 90.4% in 1988; rail fell from 68.5% in 1940 to 3.4% in 1988.  bus fell from 28.2% in 1940 to 6.3% today.  Why?

 

                        2.  Private carriage: accounts for 81.2% of intercity passenger miles; most by auto, some by air

 

II. Transportation demand: a derived demand dependent on the demand for other goods and services

            A. Aggregate demand for transportation service=f(GNP)

 

            Demand for tonmiles of transport: Definiton: One tonmile is one ton moved one mile or 1/2 ton moved two miles.

 

Wilson's estimated aggregate demand function: T = 224 + 2.31 GNP

(GNP in billions of dollars)

 

NOTE: Aggregate demand for transportation does not respond to short run fluctuations in freight rates probably due to the short run stability of locational patterns; in long run there is room for change.

 

Here long run elasticity of demand for transportation is larger than short run (ex: substitution of diesel power for steam; in short run there are not more tonmiles produced. In long run, however, there are location changes that end up producing more tonmiles.

 

Elasticity of transportation demand formula:

 

              N = % change in Q/ % change in P

 

Remember, if N > 1, elastic;  and price increase will lead to a decrease in total revenue.

                    if N < 1, inelastic; and a price increase will lead to an increase in revenues.

                    if N = 1, price increase or decrease (slight) will not change total revenue.

 

What determines the elasticity of demand?  Since it is a derived demand, it is dependent on the demand in the market for the final good being transported.  If there is a change in the freight rates, what will this do to the quantity of transport service being purchased?

 

    Must look at the commodity:

    How much of the final delivered price is contributed by the freight rate?

 

(1)        pDEL = pc + pT

 

Where PDEL is the delivered price of the commodity

      pc is the F.O.B. (free on board) price opf the commodity

      pT is the transportation price

 The percentage of transportation price in the final delivered price is pT/ pDEL or

 

(2)        pT/ (PT + pc) = 

 

            Now, lets say there is a change in the pT = 10% = s.

 

(3)        The percentage change in the delivered price is  s;

if   = 25% and s = 10%, the percentage change in pDEL = 2.5%.

 

Now what is the elasticity of demand for transport?

 

         NT = % change in Q/ % change in PT

 

(4)      NDEL = % change in Q/ % change in pDEL

               

(5)      % change in pDEL =  s

 

(6)     % change in Q = NDEL(% change in pDEL)

 

% change in Q = NDEL  s;

 

NT = NDEL s/s = NDEL      

 

So what happens if distance increases: ex:

 

Corvallis to NY ( =5%) instead of Corvallis to Portland ( =15%)? Demand becomes less elastic.

 

A monopoly supplier of a transport service only has the incentive to reduce prices if NT > 1.  For this to be true:

 

            (7) 1 =  NDEL;

 

So if  = .05, NDEL must = -20 for NT =1.

     if  = .30, NDEL must = -3.3 to make NT = 1.

     if  = .10, NDEL must = -10 to make NT = 1.

 

Typical values for   are less than 10% (.1);

            Ferrous mining = .9.1%

            Lumber and wood products = 5.1%

           

typical estimates of the NDEL:

            wheat      -.18

            corn       -.49

            potatoes   -.31

            autos      -.6 to -1.1

            furniture  -1.48

 

Thus, NT is bound to be inelastic so monopoly producer would raise price.(Exactly what the railroads did at the turn of the century).  If society seeks lower freight rates they must have:

                        1) Regulation

                        or

                        2) Competition within the transportation industries.

 

Other elasticity concepts:

 

            Cross-elasticity of demand

            Income elasticity of demand > 1 normal (air)

                                        < 1 inferior good (bus)

            Time elasticity of demand

                       

For estimates of elasticities of transport demand for freight, see Winston studies.

 

B. Intermodal competition: What determines which mode a shipper will choose?

                        D = f (price, service quality)

Will shippers be indifferent between air and rail transport ? Or passengers indifferent between air and auto?

 

            1. Dimensions of service quality for freight

                        a) Minimum size of shipments

                           importance during economic downturn

            b) Speed of delivery: especially important with perishables (flowers, agricultural commodities (East of Eden rail shipping of lettuce example).

High value commodities need to reduce inventory/sales ratio; depends also on interest rates---carrying costs.

c) Susceptibility of goods to loss and damage: may be more a function of handling rather than transportation type

d) Dependability of service: depends some on management; not only speed, but variability of speed--- rail operation complexity leads to more opportunities for delay in switching yards, etc.

                                    Rail schedules less assured.

e) Flexibility of service: door-to-door service, less handling, less transit time.

 

Importance of quality features vary highly amongst shippers; only shippers know the non-transport savings that accrue from different service qualities.  Efficient allocation of traffic amongst modes requires rates that are based on relative costs which include the value of service quality.

 

Trucks can handle smaller shipment sizes (LTL traffic) than rail.

 

Indifference rail rate PR = PT -(Value to the shipper of the                                                                       service quality difference)

If truck has superior service quality, rail must offer lower transport rate to be competitive. 

 

Especially important to rail have been:

1) the value to shippers of minimum shipment size (this has been rising over time as there are more brands and styles; emphasis on just in time inventories which reduces average shipment sizes)

            2) value of time in transit

 

Over time there has been an increase in commodity value per unit of weight, improved distribution systems and more reliability by trucks, higher interest rates.

 

As of 1965-67, shippers paid less than a 20% premium to ship by truck rather than rail.  This was enforced by ICC regulation of the industry. 

 

***Explain how this led to decline of Railroads***.

 

Difficulty of measuring non-price aspects for freight.

 

Dimensions of service quality for passengers:

 

Service quality differences between passenger transport modes are similar to freight, but the primary concern is time:

 

a) Schedule delay

b) Reliability of service

c) Time in transit

d) Flexibility

e) Comfort of the ride

 

In general, passenger demand depends on whether the trip is for business or recreation.

 

For business travelers, service quality (frequency of service, etc.) Is most important.  Recreation passengers are more sensitive to fares.

 

 

III. Transportation supply; costs

 

            A .Importance of fixed versus variable costs: the larger fixed costs, the longer ATC declines.

            Ex: Railroads and pipelines have large fixed costs partially because they must cover their own right of way as compared to trucks and water transport who have fixed costs of right of way subsidized by government.

 

            It is important ot fully utilize equipment; problems with excess capacity in railroads: how do you define capacity: per car, network system, etc.?

            Marginal cost of additional traffic is very low; large fixed costs of track and cars that must be covered anyway.

 

            1. Dimensions of utilization

                        a) Load factor: percentage of capacity used on a particular trip

                        b) Frequency of service: one rail train may be used to make one trip/day or ten trips/day.

                        Railroads have long suffered from excess capacity.

 

                        Trucks: load factor is most important dimension since most of cost is operating cost of labor and fuel.

 

                        Terminology: LTL vs. TL (truck)

                                                    CL vs. LCL (rail)

                        B. Long run costs:

 

                        1. Economics of scale

                                    a) Constant cost: airlines, motor carriage, water

                                    b) EOS: Rail, pipelines

 

                                    Pipelines purely technological:

               Volume = II r2 l

               Surface = 2IIr l

 

                                    Cost = f(surface area);  Output = f(Volume)

 

                                    Ex: Say r = 2; Volume = II4*l

                                                                        Surface = 4II*l

                                                                        so Cost = A(4II*l) and

                                                            average cost = A(4II*l)/ II4*l = A

 

                                    Now r=3;       Volume = II9*l

                              Surface = 6II*l

                              Cost =  A(6II*l)

                         average cost = A(6II*l)/9II*l = 2/3A

 

                                    So with pipelines, EOS with increased pipeline radius; pumping technology puts limits on size of pipeline.