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Friday, September 01, 2006

Microeconomics Quiz of the Week

From the WSJ's weekly microeconomics update:
"From January through July, Stockholm tested one of the world's most
sophisticated traffic-management systems as part of a plan to reduce gridlock, lower smog levels and improve quality of life in the city. Unlike most other traffic-control plans in place in cities such as London and Rome, Stockholm used a dynamic-pricing system in which drivers were charged different amounts depending on the time of day....

The project is essentially a giant behavior-control experiment designed to distribute traffic more efficiently throughout the day and to spur more people to take public transportation. The approach, known as 'congestion pricing,' first gained attention in the 1950s through work by Nobel-prize winning economist William Vickery. He theorized that billing drivers for driving at peak hours would give them an incentive to modify their routines. Because even small declines in the volume of cars on the road can have a huge impact on the flow of traffic, some economists believe pricing could eliminate some of the worst snarls." The article reports that people made three types of changes in their behavior in response to the peak-hour pricing: they commuted during off-peak hours; they commuted by bicycle or public transportation; or they altered their routes to avoid tolling points. The effect of these changes is that the off-peak commuting, public transportation, and bicycle traveling reduced congestion and auto emissions. The shift in routes to avoid tolling points probably increased congestion and pollution.

The article also reports that the past six months has been an experiment about the effectiveness of the system. The city has scheduled a referendum next month to let residents decide whether to continue the system. If the referendum fails, city officials promise to scrap the $525 million project.

The fastblast asks the following questions, which economics majors should be able to answer with relative ease:

1.) What are the negative externalities of rush-hour commuting?

2.) Explain why congestion pricing reduces rush-hour congestion.

3.) Are auto and bicycle commuting economic substitutes? What is the effect of congestion pricing on the demand for bicycles?

4.) Does congestion pricing improve economic welfare? Graphically evaluate the changes in economic welfare associated with the implementation of congestion pricing.

5.) Assume that the $525 million cost of the Stockholm project is a fixed and sunk cost. Should Stockholm residents consider the $525 million price tag when determining whether to vote to continue the congestion pricing program?

What I find interesting is that Stockholm will put the program to a referendum. Doing so runs the risk that individual voters will decide on the program based on private marginal benefit and private marginal cost, potentially ignoring the positive externalities that the program generates. The program is designed to reduce free-riding behavior and negative externalities - putting the program to a vote invites people to slide back into the free-riding status quo ante.

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