Elasticity and Transport

The Use of Elasticity of Demand in Transport

Elasticity measures sensitivity or responsiveness specifically how one variable responds to a change in a second variable.

i Inelastic means unresponsive, ie a change in one variable results in a smaller change in a second

i Elastic means responsive, ie a change in one variable results in a bigger change in a second

Elasticity is a key quantitative tool in microeconomics that is used extensively to assess and predict the effect of a change in one variable eg price, on a second variable eg number or quantity of journeys demanded. In short, elasticity quantifies changes.

Transport operators take account of several types of elasticity in planning price and predicting output

Price Elasticity of Demand

Price elasticity of demand measures the responsiveness of demand to a given change in price. Firms can use price elasticity of demand (PED) estimates in transport to predict:

i The effect of a change in fares on quantity demanded
i The effect of a change in fares on total revenue & expenditure
i The effect of a change in indirect tax eg road charging or fuel duty on price and quantity
demanded
i The effects of price discrimination in peak/off peak. Price discrimination is where a monopolist charges different prices for the same product to different segments of the market
eg peak and off peak rail travel

Income Elasticity of Demand

Income elasticity of demand (YED) measures the responsiveness of demand to a given change in income. Governments and firms use YED estimates to predict impact on demand and revenues of:

i Economic growth: the demand for luxury items such as air travel (high positive YED) increases proportionately more than products with a low YED such as bus travel
i The business cycle: fluctuations in the demand for transport can be estimated

Road rail and air travel have high positive income elasticity of demand (YED). Economic growth is resulting in a proportionately greater increase in the use of these modes of transport. Economic growth raises incomes.

Given the high positive YED for cars, a given economic growth rate results in a proportionately larger increase in car usage.

Note increased car usage is a result of increased prosperity and the preferences of consumers and unsustainable because of resultant congestion and environmental impacts from pollution Buses exhibit low, even negative YED, and are mainly used by low income consumers

Cross Elasticity of Demand

Cross elasticity of demand measures the responsiveness of demand for good A to a given change in price of good B

Firms use cross elasticity of demand (XED) estimates to predict the impact of a rival’s pricing strategies on demand for their own products. If a competitor cuts the price of a rival service, firms use XED to predict the effect on the quantity demanded and total revenue of their own product.