Hand-out 14: Congestion and Negative Externalities
Specification
Traffic congestion as a case of market failure.
Road pricing and congestion charging: advantages and disadvantages.
Key Concepts

You need to be able to:
Draw and label the congestion diagram and explain
Explain the pros and cons of road pricing as a solution to congestion
Evaluate the effectiveness of road pricing

Diagram

The Pigou Effect:

Explanation
Up to point P1 Q1 the road is in free flow conditions that the marginal cost per journey remains constant
At any quantity of traffic above Q1, congestion sets in and marginal external costs start increase more than marginal private costs
Without intervention, the free market comes into equilibrium at P2 Q2
At P2 Q2 marginal social cost is higher than the marginal private cost
In other words, there are costs to third parties that road users do not take into consideration
Imposing road pricing on busy roads internalises the externalities
The price rises to P3 and quantity falls to Q3

Advantages
(comes from explanation of diagram)
Road pricing increases the private cost of driving OR forces drivers to internalise their external costs OR price now reflects full social cost
This will shift the supply curve left
This leads to higher market price AND lower quantity demanded.
Misallocation of resources is corrected
Depending on the system, the charge can be adjusted for busy roads to reflect demand. I.e. there is a higher price to drive on a more congested road

Disadvantages
What level should the charge be set at?
PED issues – inelastic PED means ERP less effective
Flat rate charges are regressive
An alternative to the car needs to be in place at the start of the charging scheme ie a substitute is needed
Some minor roads may not be included – hence traffic may be displaced rather than reduced
UK haulage firms will face higher costs which will reduce their competitiveness / is inflationary.
The set up costs of such a scheme could be immense
To be effective, the revenues would have to be hypothecated back in to public transport
Charges need to vary throughout day /from car to car – complex to administer needs to be used in conjunction with other solutions

Evaluation
-The effectiveness of road pricing is entirely dependent upon whether or not an alternative exists in the form of quality public transport. If this does not exist then however