What you need to know about marginal social cost

After what must have been 5 years or more, I am finally posting my first blog entry. Back then I was an undergrad with many idealistic thoughts, too many, in fact, to organise into blog entries (or at least too many for an idler like me). Then, life happens. I meant this as 'life happens and I need to take care of this and that so I have no time to write' as well as 'life happens and many of those idealistic thoughts seem to have been washed away.'

While it seems sad, the one ideal that stays with me has taken more solid form. Without the distractions of other idealistic thoughts, I have gained focus on this one. I have been learning more and more about it, academically, then professionally, and now academically again. It grows stronger that it finally defeated my laziness to write. More importantly, I became aware that to reach this one idealistic goal, I have to share this with many people. The ideal is: Sustainable Transport. So, here I go.

If you have ever discussed transport with me, more likely than not you would have heard me talking about Marginal Social Cost. This concept is the best way to demonstrate the sustainability measures of our travels. This concept underlies many, if not all, problems we currently have with sustainable transport. It is important that not only transport practitioners understand about marginal social cost, the public needs to have a grasp of what it is too. Therefore, I found it fitting to dedicate my first blog entry to talk about this concept which also happens to be my favourite transport theory.

Bearing in mind that this is my first entry after so many pent up ideas and energy, it is quite long. But I hope you can read it till the end. I tried my best to make this as entertaining as it is informative and I hope you find this interesting too!

Basic Concept

Marginal Social Cost (MSC) concept is based on a profit maximising economic concept. As most economic concepts, the premise behind MSC is that humans are rationale being craving optimality, we want to maximise 'good' things and minimise 'bad' things. This is where the concept of marginal cost pricing comes in.

Marginal Cost Pricing

Let's say we are a baker selling chocolate chips muffins. Let's look into these two definitions to begin with:

• Marginal cost (MC): is the cost of producing one more muffin to sell to the market

• Marginal revenue (MR): is the revenue we get for selling one more muffin

Our marginal revenue is simply the price of one muffin, in many situations the price of a muffin sold in a shop will be fixed no matter how many muffins we produce. Our marginal cost, however, will vary. Let's see, to make muffins we would need eggs, milk, sugar, flour, and chocolate chips. We would also need baking tray and oven. 

Let's say a sack of flour is enough to make 100 muffins and a baking tray has room for 24 muffins. If we have four trays we can make 96 muffins and have enough leftover flour to make 4 more muffins. If we want to make 100 muffins then we will need to buy one more baking tray, but then we will have enough room to make 20 more muffins. If we want to make 120 muffins, we will need to buy another sack of flour but, again, then we will have leftover flour. If we buy more trays, however, we will need a larger oven, or if we want to make the muffins in two batches then we will need more time (which can be converted into a monetary value). This illustrates how marginal cost varies depending on how many muffins we make.

Now, let's examine the situation:

1. When the marginal cost is lower than the marginal revenue, we can gain more profit by producing more muffins because the revenue we get from selling these additional muffins are higher than the cost of producing them.
2. When the marginal cost is higher than the marginal revenue, we should produce less muffins because it is not worth producing more muffins if their price is lower than the cost of production.

Therefore, our profit is maximum at the point where MC = MR. This indicates how many muffins we should sell to maximise our profit.

Basic concept of marginal cost pricing

At this point some of you might be thinking "what does muffin got to do with sustainable transport?" but I hope more of you will be thinking "I could apply this concept to get optimum benefit out of the transport system." The main thing to take away here is:

Maximum profit/benefit/values are obtained when MC = MR.

Let's now take this concept one step further.

Externalities

When we purchase a product, the costs and benefits of our purchase are incurred not only between the people involved in the transaction. There are external costs and external benefits experienced by other people. These are the externalities of a product. There are two types of externality: positive externality and negative externality. Let's examine some products and their externalities.

A classic example of product with positive externality is education. When we go to university, we pay tuition fee as the cost of the education we purchase. The benefits we get include higher chance of getting a job, exposure to research environment, and such. The education we purchase have some external benefits for the society, for example, if we are studying criminology we can use our education to help catch criminals, therefore making a city a safer place to live for society.

Transport, on the other hand, is a product with many external costs. When we use our cars, we are entitled to pay for things such as fuel, car maintenance, and driving licence as the cost of driving. However, by driving we are emitting pollution and greenhouse gases which are felt by public. In other words, society pays for the external costs of pollution. These external costs are often termed as social costs.

To be fair, it is not only about the products but also the way we are using them. Education can have negative externality if we are instead using our criminology degree to help criminals getting away with murder instead of catching them. Driving could also have positive externality if we use our car to help our neighbours commute rather than using it ourselves. These cases are examples of individual cases but in a wider context driving is more associated with negative externalities while education is more associated with positive externalities.

So, how do externalities affect the implementation of marginal cost pricing?

When we set MC = MR we obtain maximum profit for the producer. In the presence of externalities, a condition which results in maximum profit for the producer does not produce maximum benefit for society. It comes down to the question whether we should optimise benefit for a small number of people or for society. Hopefully, this is a question with a clear answer. To obtain maximum benefit for society, marginal costs calculation of a product should include its externalities (positive costs for external costs and negative costs for external benefits). The inclusion of social costs into marginal cost calculation gave birth to the concept of marginal social cost. When everything is arranged such that marginal revenue equals marginal social costs, we will have a configuration of optimum benefit for society.

So, there you have it! The MSC concept at its heart. Isn't it such a wonderful concept? 

Now, let's put some context into this concept.

The Benefits and Costs of Driving

Let's list down the benefits and costs associated with driving. Why do you drive? The main benefits of driving come down to three things: 

• Speed
  It is faster than walking or cycling. It may be faster than taking public transport if there are no services taking a direct route from where we are to where we want to go and especially because public transport journeys usually involve some amount of walking.
• Flexibility
  We are free to go when we want to, we are not restricted to services schedule as in public transport journeys. We are also not restricted by weather conditions such as if we walk or cycle.
• Convenience
  We have more room for ourselves and do not have to share this with other people. We can play the music that we like, put groceries at the back seat, take our cats, and so on.

What do you need to pay to get these benefits? The costs of driving can also be generalised into three items:

• Investment costs
  These costs include the purchase of the car, routine maintenance, license and insurance, and other costs associated with the physical entity of the car. If you are renting the car, this would be the rental costs.
• Operating costs
  These include mainly fuel and other costs associated with the amount of driving you do. Arguably maintenance cost can fall into this cost category. But some car make may have higher maintenance cost than others or may need more frequent maintenance. It is somewhere in between the investment and operating costs.
• Idle costs
  These are mainly the cost of parking at destination but also the cost of having a parking space at home (it's not always free).

Okay great, now we know the cost and benefit items of driving. Let's see how they behave in different conditions. Under normal condition the marginal cost of driving will stay more or less constant. The additional cars driving on an uncongested road will pay the 'normal' costs of fuel, maintenance, and parking. The benefits of driving may slightly vary even in the 'normal condition. When there are more cars on the road, you might need to slow down even though it is not congested and the flexibility of your driving is somewhat limited by the presence of other cars on the road.

However, at some point the number of cars on the road exceeds its capacity, this is where the road gets congested. Let's see what will happen. First, the speed benefit will plummet. In terms of flexibility, you now have to leave your house at a certain time to get to the office on time, or to avoid congestion. The convenience of driving becomes eclipsed by the stress of being stuck on traffic. The benefits of driving quickly deteriorate under congested condition.

The costs and benefits of driving under normal and congested condition

Let's now examine the costs. The most efficient fuel consumption (in litre/km) is obtained when we are driving around 50-80 km/h, lower or higher than this range, fuel consumption will increase significantly. In congestion, we may be driving at around 10 km/h which is very inefficient, thus we will need to pay more for fuel. Beyond fuel, running in sub-optimal speed will also lead to car parts such as the wheels needing more maintenance. Also, congestion increase the likelihood of bumping with other vehicles which will also costs us extra money. Last but not least, too many cars on the road often translate into packed parking space which means we will need more time to find a parking spot and the price for parking can go over the roof.

Hmm, sounds grim, right? But sadly, that's not all.

External Costs of Driving

How does it feel to get stuck in a congestion? The word 'miserable' does not seem to be excessive to describe the feeling. Now remember that you are not only the victim of the traffic jam, but you are also the cause. Yes, it is difficult to sympathise with the bastard that just cut in front of you, but maybe she needs to pee as bad as you, or maybe he wants to see his children before they go to sleep. In any case, you are causing delays to other drivers too. And, more importantly, think of the misery you are causing to the people taking the bus. Some of them may not even be sitting. This situation, sadly too common, illustrates the external travel time costs of driving.

Another important external cost of driving is the environmental costs. The burning of our fuel produces carbon dioxide which is one of the greenhouse gases causing global warming. If we want to talk about significance, the transport sector contributes to about a quarter of all CO2 emission globally, and more than half of it comes from passenger cars. Moreover, cars also exhaust pollutants into the air such as NOx and particulate matters which can cause all sorts of health problems.

Last but not least is the external urban space costs. Car-centric cities require many provisions for roads and parking lots which mean less open spaces to produce fresh air, absorb rainwater, and handle pollution. Subsequently, this accentuates the problems occurring from the external environmental costs discussed in the previous paragraph. Moreover, as not everyone can afford other mobility choices, people who are walking and cycling have to be exposed to these pollution and inadequate pedestrian facilities. Also, the land dedicated for cars and motorcycles can be used for other productive uses such as more offices or marketplaces. It can also be used for recreational activities. Green spaces are essential for us to conduct our sport and social activities thus improving the quality of our lives and, more importantly, those of our children. How much do you value an active and happy childhood for your children? These are the benefits we lose for dedicating too much space for private vehicles.

The social costs of driving

So, now we know that congestion does not only harm car users. There are also external costs incurred to society which fall under one of the three categories: 

• External travel time costs
• External environmental costs
• External urban space costs

At some point, society even pays more than car users for the benefits they do not receive, just so you can keep on driving. Now, where's the sense in that?

So, are you feeling uncomfortable yet? Are you feeling sad, worried, troubled, uneasy, with this situation? Are you feeling the unbearable need to change? Well, good!

What can we do now? How should we change? The simple answer is that we need to get motorists to pay equal to the marginal social costs to get an optimal configuration for society. But of course, it's not that simple. That is why there are jobs for transport practitioners and researchers like me.

The posts in this blog will be dedicated to try and answer these questions, so stay tune!

Thanks for reading! I'd love to hear your transport thoughts in the comments!

Tafta