Thursday, May 10, 2012

Car Savings

In discussing the potential savings from using our service, we have focused a lot on what a businessman would call “operational expenditures.” These are the expenses that are incurred on a day to day basis to carry out daily activities. Watching my own father get to work every day, though, I wonder if I missed out on a potential big savings that might be the biggest of all. This savings would be more properly characterized as a “capital expenditure”, or an expenditure of funds to procure something which will serve for a number of years.

Simple question: How many people, if they signed up for our service, could do with one less car in the family?

In a country with 308 million people in it, there are a little over 200 million cars and light trucks in operation. Given that roughly 60 million people in this country are too young to drive, and that there are a little over 24 million people who have a severe disability making it difficult or impossible to drive themselves, and just about everyone who can drive a car owns one. This will come as no surprise to California residents, who have probably seen every one of them during rush hour in Los Angeles. But given that fact, it seems logical that a high number of corporate commuters(who after all do not need to go anywhere except to and from work during the busiest times of day) own one of their cars solely for the purpose of getting themselves to and from work. If Rideshare could furnish a convenient and reasonably priced alternative to doing that, corporate commuters might be able to save on the costs of the car completely by not replacing the oldest car in their family when it dies. That would represent a major savings and an additional incentive to use our service.

So just how much would the average corporate commuter save if they had one less car in the garage?

Kelley Blue Book has the average price of a new car in 2011 around $30,000. Of course, not everyone buys cars new. But for everyone who buys a used car there is someone who sells one, and then has to replace it with a new one, so any reduction in the total demand for cars will ultimately find its way into the new car market. Now, not everyone who uses our service will reduce the number of cars in their family, obviously, but let’s take that number and calculate the savings for someone who does.

At current interest rates, interest expense for buyers with good credit are very low, so to reduce the math here and to be conservative with our estimates, we’ll set the interest cost at 0 and just use the purchase price. A five-year loan is most common, so that’s 60 months. A person who elected to forego a new car and its five year payment plan would save $500 a month in car payments. New cars need an oil change once every five months(the so called experts used to say three, now its five), which costs about $30. So that’s $6 more a month in oil changes. Figure a one-time tune-up when the car hit the 50,000 mile marker. Let’s be conservative again and say that’s only $500. Throw in new tires and new brakes once every couple of years, insurance for the extra vehicle. All told, you get something like this:

Car Payment $500
Oil Change $6
Tune-up(monthly distributed cost) $6.33
New tires(monthly distributed cost) $7.67
Brakes(monthly distributed cost) $5
Insurance $95

I made the new tires $460 and $300, since those are the conservative numbers for good quality of both, which new car buyers usually spring for. If our member foregoes the purchase of a used car, the car payment is lower, but the maintenance and repair costs are higher. So figure everyone comes to around $620 a month in car savings. That outweighs even the other savings we discussed in our Meet Rideshare series. While obviously not everyone will take advantage of these savings, the very high penetration of car ownership amongst possible buyers(upwards of 90% according to the data above) means that quite a few of them might. Add the cost of fuel and that number is around $8,000 a year or 15% - 25% of an individual's income for the cost of transportation.

Wednesday, May 2, 2012

Highways as Public Goods

And why are highways, unlike so many other forms of investment, deserving of public support for their construction and maintenance?

Let’s start with why highways are publicly supported. Transportation links are different from most other forms of private investment because transportation links generate large spillover benefits(the technical term economists use is “positive externalities”) for the general public. Spillover benefits are essentially third party benefits. When you get a vaccination against a contagious disease, for example, the doctor gets a benefit(what you paid for the vaccination), and you get a benefit as well (a higher probability of staying in good health). But the rest of the general public gets a benefit as well. They also are more likely to stay in good health because of your being vaccinated, since if you don’t get sick they can’t catch the disease from you. However, the private market, which communicates via prices paid, doesn’t see external benefits to third parties. It only sees the benefits to the people who are actually paying and receiving the money changing hands. This means that the private market sees all the costs of vaccination(the doctor will incorporate those costs into the price of the vaccine) but only part of the benefits(the patient will not pay for the good health of others, only his own good health). So the private market underestimates the benefits of vaccination and how much vaccination is socially efficient. Highways also generate substantial third party benefits. What this means is that if the private market was left to it’s own devices it would underfund the highway system, making less investment in it than it should.

The spillover benefit of a highway system, or any transportation system for that matter, actually has a lot of different names among economists. Two of my college professors call it “market expansion”, others call it “competition support”, etc. But it might be best to illustrate just with another example.
Say there are two cities, each with one car manufacturer plant in them. There are no highways to travel between these two cities(though there must be roads within the cities that they use, or else there wouldn’t be a car manufacturer right?) Because there are no inter-city roads, each car manufacturer has a monopoly on car sales in their city. Each car costs $10,000 to make, including fair return on capital, and each customer in the city derives a benefit of $15,000 from their car. This means that the car manufacturers in each city are deriving $5,000 in monopoly profits on each car. They sell each car for the full $15,000 that a customer is willing to pay, because there is no competition to force them to charge a fair price closer to the actual cost of production.

What, you say, does any of this have to do with highways? Let’s say there are 50,000 cars sold in each city each year. Also say that a highway costs $20 million to build between the two cities and will last for 20 years. And finally, say it costs $100 to drive a car from one city to the other.
With a highway now built and a cost of $100 to move a car from one city to the other, prices start to fall. TWO car manufacturers are now competing with one another. They begin to offer lower prices hoping to win away customers from the other manufacturer. As each cuts prices, customers benefit. Eventually prices will fall to $10,100. Why? Because that is the cost of going to get your car in the other city if the car manufacturer is not offering you a good deal. $10,000 to build the car, plus $100 to ship it to the other city.

But wait a minute. Each car manufacturer has one last insight. “If my competitor CANNOT charge less than $10,100 without losing money, than I have an advantage in my own city. I don’t have to pay the $100 to ship the car on the highway when I am selling to customers in my own city. So I can charge $10,099 to customers in my own city and they will never buy a car from the other city, since it will always be cheaper to buy it here.” So the price drops to $10,099.

BUT, that means NO ONE is shipping cars on the highway. Those car buying customers are not contributing one dollar towards the highway that is saving them $5 million a year total in car costs.
Highways have large, uncompensated positive externalities because they increase the size of markets. They bring many smaller markets together to form one larger market with more competition and lower prices for consumers. But because what actually travels on the highway is only a small fraction of the goods that have seen their prices drop, highway builders are never fully compensated for this market effect. This persistent underfunding of transportation links is what necessitates public investment in the nation’s transportation infrastructure.