Flashcards in BUSI 300 Lesson 8 Deck (12)

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## You are about to purchase a house in the city of Drivemwilde, a small open city. You have narrowed your options to two properties, one in the central city and one near the periphery of the urban area. The properties are identical in all other respects. Since everyone in Drivemwilde is identical, and the markets there are perfectly competitive, you would be indifferent among the houses if you did not posses an important piece of private information. You know that at its next meeting, the city council will unexpectedly impose congestion tolls on auto commuting, the only form of travel in the city. Which property should you choose? Distinguish between short run and long run impacts. Use a diagram in your explanation.

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You should probably choose the central city property. In the short-run, the imposition of tolls will

increase the marginal cost of commuting, cause the housing price function to get steeper, and increase

prices at all locations. With higher housing prices and commuting costs, utility in this city will be lower

than utility elsewhere, and emigration will occur. Thus, in the long-run, the city will shrink (the

boundary will move inward) and the housing price function will shift downward. Prices near the edge

of the city will fall. If there is a fixed factor that is less congested in the now smaller city, prices near

the city centre will rise. The diagram should look like Figure 9.8.

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## Explain why capacity expansion is not an effective solution to the problem of peak period highway congestion.

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The basic problem with capacity expansion is Down's law, or the law of highway congestion. Some

drivers are discouraged from using congested highways precisely because they are congested. Capacity

expansions may temporarily reduce congestion, but this will just encourage more people to drive. Thus,

in the absence of road pricing, capacity expansion is self defeating. There are well documented cases

of an increase in capacity leading to an increase in traffic congestion.

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##
Suppose that the demand for travel along a particular road is given by V = 16 - P, where V is the number of trips (traffic volume) and P is the price per trip. Suppose further that the private cost of travel equals 4 + V, and the marginal external cost of travel equals V.

(a) Find an expression for the marginal cost of travel.

(b) Solve for the equilibrium and optimum levels of traffic volume, and show these solutions in a diagram. (Hint: You will need to rearrange the demand equation to solve for P first.)

(c) Is some congestion efficient in this case? Explain. What is the capacity of the road?

(d) Explain intuitively why there is too much road use in equilibrium.

(e) Find the congestion toll that will induce drivers to take the optimum number of trips, and show this toll in the diagram from part (b).

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(a) The marginal cost equals the private cost plus the external cost, so MC = 4 + 2V.

(b) Equilibrium volume occurs where the demand and private cost curves intersect. P = PC

implies 16 V = 4 + V implies V = 6. Optimum volume occurs where the demand and 1

marginal cost curves intersect. P = MC implies 16 V = 4 + 2V implies V = 4. The 2

diagram should resemble Figure 9.7, except that the PC and MC curves both have an intercept

of 4 on the vertical axis. The MC curve is twice as steep.

Note: Diagram is included on next page.

(c) The capacity of the road is actually 0 in this problem, and so there is congestion at the efficient

traffic volume V . 2

(d) Each driver ignores the impact of his travel decision on others, and this negative externality

leads to excessive road use.

(e) The required toll equals EC at V , or $4 per trip. In the diagram, this is the vertical distance 2

between PC and MC at V .

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Why has transit been unable to compete effectively with the automobile?

(1) The transit system has not yet been able to set up efficient time schedules.

(2) The transit system has not been able to grow large enough to effectively compete with the auto.

(3) The costs of transit, including the opportunity cost of time spent travelling and waiting and the walk to and from the bus stop, are higher than the costs of travelling by auto.

(4) None of the above are correct.

### Answer: (3) All of the factors that influence travel choices, including the monetary costs of travel, the opportunity cost of time spent travelling, and trip characteristics like convenience and comfort, make transit travel more costly than auto travel for most trips.

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If T(V) represents travel time as a function of traffic volume, what is the basic shape of the curve?

1) Travel time will remain constant until some critical level where it will begin to slope upwards.

2) Travel time will remain constant until some critical level where it will begin to slope downwards.

3) Travel time will slope upwards until some critical level where it will become constant.

4) Travel time will slope downwards until some critical level where it will become constant.

### Answer: (1) Travel time is constant as long as volume is less than some critical level C, which represents the capacity of the road, or the capacity of a bottleneck if one is present. As volume increases beyond C, congestion sets in, and travel time rises because speeds fall or because drivers are waiting in a line.

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##
Why is the private cost curve lower than the marginal cost curve when the volume is above capacity?

(1) The private cost curve is lower than the marginal cost curve because the fixed costs are now being spread among more users.

(2)The private cost curve is lower than the marginal cost curve because as volume increases the private costs decrease.

(3)Each driver ignores the fact that he or she causes travel time for others to increase. This external cost of travel is not being paid by each additional driver and therefore the marginal cost per additional driver is more than the additional driver's private cost.

(4) The private cost curve is lower than the marginal cost curve when the volume is above capacity. Every additional driver is paying for the congestion that they cause.

### Answer: (3) When looking at Figure 9.6 in the text, we see that the private cost curve and the marginal cost curve coincide until traffic reaches capacity. Beyond this point, marginal cost is larger than private cost; the difference is the external cost of travel. Each driver ignores the fact that he or she causes travel times for others to increase which leads to congestion problems. The marginal cost per additional driver is more than the private cost to that driver.

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Carla drives to work. She drives along a perfectly straight road for 15 kilometres and it takes her 15 minutes. The capacity of the road that Carla travels on is 1,500 cars per hour. The monetary cost of a trip is $4 and Carla values her travel time at 30 cents per minute. When the volume of cars exceed 1,500 per hour, the travel time is given by the equation V/45 - 14.

What is Carla's private cost of a trip in dollars if there are fewer than 1,500 cars on the road per hour?

(1) $9.42

(2) $8.50

(3) $4.54

(4) $4.00

### Answer: (2) The private cost in dollars is equal to PC = 4 + .3(15) = $8.50.

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##
Carla drives to work. She drives along a perfectly straight road for 15 kilometres and it takes her 15 minutes. The capacity of the road that Carla travels on is 1,500 cars per hour. The monetary cost of a trip is $4 and Carla values her travel time at 30 cents per minute. When the volume of cars exceed 1,500 per hour, the travel time is given by the equation V/45 - 14.

What is Carla's trip cost if there are 2,000 cars on the road per hour?

1) 950

2) 1,004

3) 1,425

4) 1,650

### Answer: (1) When the volume is higher than the capacity, we use the formula PC = 4 + .3(V/45 ! 14). Therefore, PC= 4 + .3(2,000/45) ! 14) = 13.13.

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##
Carla drives to work. She drives along a perfectly straight road for 15 kilometres and it takes her 15 minutes. The capacity of the road that Carla travels on is 1,500 cars per hour. The monetary cost of a trip is $4 and Carla values her travel time at 30 cents per minute. When the volume of cars exceed 1,500 per hour, the travel time is given by the equation V/45 - 14.

What should the congestion toll be to make more efficient use of the road capacity during peak periods?

1) The toll should be equal to the external cost of travel at the efficient traffic volume.

2) The toll should be equal to the MC minus the PC at the efficient traffic volume.

3) The toll should equal the amount that makes drivers take the full marginal cost of their decisions into account. 4) All of the above statements are true.

### Answer: (2) To solve for the equilibrium traffic volume, we set p = PC in the demand curve and solve for V: V = 3,600 ! (800/2)(4 + .3(V/45 ! 14) = 3,600 ! (400)(V/150 ! 0.2) = 3,680 ! 8V/3 therefore V = 3,680 ! 8V/3 and if you solve for V you get V + 8V/3 = 3,680, V = 1,004.

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##
You are about to purchase a house in the city of Beryperty, a small open city. You have narrowed your options to two properties, one in the central city and one near the boundary of the urban area. The properties are identical in all other respects. Since everyone in Beryperty is identical, and the markets there are perfectly competitive, you would be indifferent among the houses if you did not possess an important piece of private information. You know that at its next meeting, the city council will unexpectedly impose congestion tolls on auto commuting, the only form of travel in the city. (For guidance refer to Figure 9.8 and the corresponding explanation. Note that the higher graph displays short-run effects and the lower graph displays long-run effects.)

What are the short-run effects of the unexpected implementation of congestion tolls on auto commuters?

1) In the short-run, the housing price function will shift in and up, making houses near the city centre more expensive and making the size of the city smaller.

2) In the short-run, the housing price function will shift out and down, making houses near the city centre less expensive and making the size of the city larger.

3) In the short-run, the housing price function will become steeper and house prices at all locations will increase.

4) In the short-run, the housing price function will become flatter and house prices at all locations will decrease.

### Answer: (4) The direct way to make more efficient use of the road capacity is to charge a price or congestion toll for road use during peak periods. The toll should equal the external cost of travel at the efficient traffic volume. Such a toll will make drivers take the full marginal cost of their decisions into account, and lead to efficient travel decisions.

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##
You are about to purchase a house in the city of Beryperty, a small open city. You have narrowed your options to two properties, one in the central city and one near the boundary of the urban area. The properties are identical in all other respects. Since everyone in Beryperty is identical, and the markets there are perfectly competitive, you would be indifferent among the houses if you did not possess an important piece of private information. You know that at its next meeting, the city council will unexpectedly impose congestion tolls on auto commuting, the only form of travel in the city. (For guidance refer to Figure 9.8 and the corresponding explanation. Note that the higher graph displays short-run effects and the lower graph displays long-run effects.)

What are the long-run effects of the unexpected implementation of congestion tolls on auto commuters?

1) In the long-run, the city will grow and the housing price function will shift upward.

2) In the long-run, the city will shrink and the housing price function will shift downward.

3) In the long-run, the housing price function will become flatter and house prices at all locations will decrease.

4) In the long-run, the housing price function will become steeper and house prices at all locations will increase.

### Answer: (2) With higher housing prices and commuting costs, utility in this city will be lower than utility elsewhere, and emigration will occur. Thus, in the long-run, the city will shrink (the boundary will move inward) and the housing price function will shift downward. Prices near the edge of the city will fall. If there is a fixed factor that is less congested in the now smaller city, prices near the city centre will rise.

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