Chapter 8
The pricing of transport
activities
Contributed by Stephen Ison
Learning Outcomes:
On reading this chapter, you will learn about:
᭿ Price discrimination in the pricing of transport services
᭿ Pricing malpractice, namely predatory pricing, as it has been applied in transport services
and price ﬁxing, and thus what constitutes ‘fair’ and ‘unfair’ pricing policies in the
pricing of transport services
᭿ A closer examination of private transport services with a particular focus on the pricing
of such services.
INTRODUCTION
Pricing is a vital component in the economics of transport services. As we have already seen, not
only does the price determine who gets and who doesn’t get a particular service, but also
determines the distribution of the ‘rewards’ between the provider and the user of transport
services, with imperfect market structures characterised by higher rewards for the providers of
such services. That of course assumes that transport services operate along purely free market
principles, which of course in most cases they do not. Although most are subsidised and/or
regulated, a basic understanding of these issues is required before we go on and examine the issues
of transport regulation in Chapter 10.
In this chapter therefore we examine further the issues surrounding the pricing of transport
services. Earlier chapters have already outlined the theory behind the price, with in simple terms
the price being dependent upon the market conditions facing the individual ﬁrm. An important
ﬁnding from that analysis was that in order to achieve economic eﬃciency the price should equal
the marginal cost. This chapter will also consider how people actually pay for their transport
services, as in many ways the pricing of transport is very diﬀerent from a typical consumer good.
With say a basic commodity such as groceries and general foodstuﬀs, the price is displayed and
people hand over cash or some other form of payment and consequently obtain the groceries that
they desire. With regard to the payment for transport activities, however, it is far from straightforward.
Individual bus or rail journeys tend to follow that basic pattern of payment of a fare
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followed by consumption of the service through undertaking the actual journey; however, more
regular travel brings with it a host of other issues, such as season tickets, the use of smart cards etc.
Furthermore, the pricing of private transport services is more complex again, as that is ‘paid’ for
through a combination of diﬀerent mechanisms – not only directly by the user through vehicle
purchase, vehicle licensing, fuel and other running costs, but also through the tax system, which in
most developed countries makes a signiﬁcant contribution to the upgrade, maintenance and
renewal of the road system. This is an area which is likely to see considerable change in the near
future, with far more emphasis placed on a direct user charge, and this chapter will consider the
key points surrounding this issue.
PRICING IN PUBLIC TRANSPORT SERVICES
The price set by public transport operators, particularly if they are operating under conditions
of monopoly, will depend on ‘what the market will bear’. The reason for this is that the market
does not consist of homogeneous consumers. Diﬀerent parts, or segments, of the market will
comprise of customers who will respond diﬀerently to changes in price, advanced booking
requirements, ticket ﬂexibility and so on. Thus market segmentation. When considering pricing
under a monopoly situation then the various segments will have diﬀering levels of elasticity, and
this can be used to the operator’s advantage when deciding what price to charge. As such,
individuals undertaking work-related journeys during peak times, with inelastic demand, can be
charged a relatively higher fare as can be seen in Table 8.1. Individuals however for whom the
journey time is somewhat less important, and therefore where demand is relatively more elastic,
will be charged a lower fare in order to stimulate travel. What is known as price discrimination
will therefore be undertaken, in order to maximize revenue and this is likely to take place at the
national public transport level, namely with respect to rail and airline travel.
In terms of local public transport, then, passengers tend to purchase their tickets at the ‘point of
use’, that is, at the time of departure and in such a situation it is not possible to segment the
market. In addition, local public transport passengers are likely to be more sensitive to waiting and
journey times than they are to the level of fares.
Price discrimination
Price discrimination refers to a situation where a company charges particular consumers a higher
price than others for the same product for reasons unrelated to cost. Price discrimination is
extensively used in the transport sector with bus, coach, rail and airline operators charging a range
of prices for the same service depending on the time of the day, when the tickets are booked or the
particular period time of the year. It does not simply refer to transport services, however, but can
also be applied in other areas of transport operation, such as the pricing of car parking spaces. An
example of this can be seen in Table 8.1 where the car park tariﬀ varies depending on the number
of hours parked, which is simple market pricing, or whether it is a weekday or Saturday, which is a
classic case of price discrimination.
The basic principle of price discrimination is to increase an operator’s total revenue and
earn higher proﬁts, and as a result reduce consumer surplus. Consumer surplus is a concept that
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THE PRICING OF TRANSPORT ACTIVITIES
has been dealt with in the previous chapter, but given its importance to price discrimination it is
worth recapping here. Consumer surplus refers to the diﬀerence between the actual price a
consumer pays for a product and what they would be willing to pay. As such, in Figure 8.1 the
actual market price is P1 but some consumers would be willing to pay a price as high as P2, some
would be willing to pay a price just below P2 and so on. There is thus consumer surplus equal to
the area abc and this is something that transport operators are keen to exploit by price
discrimination.
In order to practise price discrimination and reduce the consumer surplus certain conditions
must prevail. First, the seller must possess a degree of market power, although the operator does
not have to be a monopolist. Possessing a degree of market power means that the seller faces a
downward sloping demand curve. Second, the seller must be able to divide the market into
individual segments and thus separate diﬀerent customers within a particular market, such as peak
and oﬀ-peak. These segments must be clearly divisible and there must be no mechanism through
Figure 8.1 Consumer surplus
Table 8.1 Weekday and Saturday opening
times and daytime charges, Grand Arcade
7.30am – 5.00pm, Cambridge, from April 2008
Hours Weekday Saturday
tariff £ tariff £
................................................................
0–1 1.60 1.80
1–2 3.20 3.60
2–3 4.80 5.40
3–4 8.00 8.80
4–5 14.50 16.50
5+ 21.00 21.00
Source: Cambridge City Council (2008)
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THE PRICING OF TRANSPORT ACTIVITIES
which high-yield premium charge consumers can ‘down trade’ to the lower-charge segment.
Such market dividers are known as inhibitors and prevent trading between diﬀerent market
segments from occurring. This tends to mean that price discrimination is more likely to be
practised in service industries, such as transport, where the market can be divided relatively easily
in terms of time. Indeed, divisions tend to be on the basis of time of day, day of the week or season
of the year. Other inhibitors can be based upon geographical location, age and time of purchase
(booking).
Third, each market segment must have diﬀering elasticities of demand. There is no point
in dividing up the market into diﬀerent segments if all segments have identical elasticities of
demand, as each could only be charged the same price and hence there would be no price
discrimination.
Ideally, an operator would like to sell each unit (or ticket) separately, charging the highest price
that each consumer is prepared to pay and if this was achievable the seller would obtain the entire
consumer surplus from the consumer. This can be illustrated by the use of Figure 8.2 and is known
as perfect price discrimination.
To undertake this form of price discrimination the seller must know the exact shape of each
consumer’s demand curve and perhaps with more diﬃculty charge each consumer the maximum
price they are prepared to pay. In Figure 8.2 if the supplier was a proﬁt maximiser then it would
charge a price of Pm, earning abnormal proﬁt of bcde, with the consumer obtaining consumer
surplus of abc. If the seller was able to perfectly price discriminate then the consumer willing
to pay the highest price would be charged P1. Having sold that unit the second unit would be sold
for a slightly lower price and so on. As such, the seller would charge down the demand curve,
which would thus become the marginal revenue curve. The operator would continue to sell the
product until point f is reached, with a quantity of Q1 sold. The operator would be proﬁt
maximising (producing where MR=MC) and would have obtained the entire area of consumer
surplus.
Figure 8.2 Perfect price discrimination
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THE PRICING OF TRANSPORT ACTIVITIES
This type of price discrimination is an ideal from the point of view of a transport operator, but
for obvious reasons is not very common. While it is not a common practice airline operators by
practising yield management are aiming to get somewhere close to such as situation, and this is
illustrated in the following case study.
Case study 8.1 Sale of airline tickets
On a typical airline ﬂight there are three classes, namely First, Business and Economy. Figure
8.3 refers to travel in a particular class and the assumption is made that the marginal cost
(MC) of one extra passenger is constant up to the point where the aircraft reaches full capacity,
which is represented by Q5. At this point the MC curve becomes perfectly inelastic.
If the airline operator was to proﬁt maximise it would set a price equal to P2 and sell a
quantity of Q2 tickets. As can be seen however this would mean that the airline would be
operating at below full capacity, with Q5-Q2 seats empty at the time of departure. As such, the
airline operator would seek to price discriminate and release seats onto the market at different
prices at different time periods. This it is able to do because consumers will purchase their
tickets at different times. For example, certain passengers will have a low ability to pay but will
be able to book well in advance. As such, they may be able to buy their tickets at a price of P4.
Others who are only able to ﬁnalise their travel plans close to the time of departure may be
willing to pay P1. As these consumers have different price elasticities, this allows the airline to
price discriminate.This it does by pricing along the demand curve and although they may not be
able to perfectly price discriminate they are obtaining additional areas of consumer surplus and
are therefore adding to their level of proﬁt. Technically this is known as 3rd degree price
discrimination, as each group of consumers is charged a different price. 1st degree on the other
hand occurs where each individual consumer is charged a different price, hence perfect price
discrimination would be an example of this.
Figure 8.3 Airline price discrimination
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Airline operators are able to price in this way since they are able to separate their customers
and prevent arbitrage and this is possible since tickets when purchased are not transferable.
When purchased the passenger needs to give a particular name and when checking in this is
matched against the name in the passport and this prevents arbitrage taking place.
Airline operators have become highly sophisticated in determining how many tickets to issue
onto the market at any one time, providing them with the opportunity to maximise their yield.
Yield management is an important strategy for the airline sector be it traditional carriers or
low-cost operators. The following relates this to load factors, yield management and airline
pricing as outlined by the Eddington Study (2006).
Airlines therefore proﬁt maximise through revenue maximisation by practising price
discrimination. In so doing, airlines attempt to obtain the largest level of passenger revenue for
a ﬁxed level of capacity.
Source: Crown Copyright Eddington Report (2006)
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Pricing along the lines outlined in the above case study can actually be of beneﬁt to consumers.
Figure 8.4 illustrates a situation in which a transport operator charging a single price of P1 is
making a loss of bdfe. This could represent an airline operator serving a remote sparsely populated
area and as can be seen it is not covering its average cost and consequently it would cease operating
in the long run. If however it were to charge more than one price it might be able to make a proﬁt
and continue to operate the service. If, as explained above, the operator was to price down the
demand curve starting at point a, then those airline tickets sold would be proﬁtable as they would
be sold at a price above the average cost. Tickets sold beyond c up to point f and the output of Q
however would represent loss-making sales to the airline operator. Nevertheless, as long as area abc
is greater than area cdf then the strategy will lead to a proﬁtable outcome and the passengers will
continue to ﬁnd the service is in operation.
Whilst perfect price discrimination is an ideal strategy from the operator’s point of view it is
very diﬃcult and costly to practise. As such, operators may practise a more crude form of price
discrimination dividing the market into two or more segments based on diﬀerent price elasticity
conditions. This is a policy of charging diﬀerent prices to consumers in diﬀerent markets and is a
common type of discrimination characterised by such things as discounts to students and senior
citizens and peak and oﬀ-peak rail use. In each case some characteristic has been used to divide
consumers into distinct groups such as students and non-students who have a diﬀerent ability and
willingness to pay. In this situation the student union card is used as a means of enacting price
discrimination.
The idea behind this more common form of price discrimination can be seen in Figure 8.5.
In this situation there are two markets, markets A and B. The demand in market A is less elastic
than it is in market B. This could represent the peak and oﬀ-peak nature of rail travel, with the split
between the commuter and the leisure rail user. The overall quantity in Figure 8.5(c) is derived by
the horizontal summation of the demand in market A and B. If only one price were to be charged,
Figure 8.4 Loss making operator and perfect price discrimination
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THE PRICING OF TRANSPORT ACTIVITIES
under conditions of proﬁt maximisation (MR=MC), then the price charged would be £33 and 30
units would be sold. If the MC/AC is constant at £20, then the abnormal proﬁt earned would be
£390. In terms of markets A and B this would represent 20 units sold in market A and 10 units sold
in market B.
If an operator were to practise price discrimination and charge a price where MR=MC in each
market separately then it would be possible to increase its level of proﬁt. Thus a price of £40 could
be charged in market A with 15 units sold (which is where MRA = MC in market A) and a price
of £30 charged in market B with 15 units sold (MRB = MC in market B). This would result in
abnormal proﬁt of £450 representing an increase in proﬁt of £60. Clearly this is at the expense of
consumer surplus, but the passengers who make up market B do in fact beneﬁt since the price
charged to them is less than it was before price discrimination was undertaken.
It might not however be worthwhile for the operator to sell to more than one group of
consumers. In fact it may be that demand is so low in one market and so costly to provide to that
market that the operator may be better oﬀ charging a single price and selling only to the larger
group, since the additional cost of serving the smaller group could outweigh the additional
revenue.
While the above relates to price discrimination and charging passengers what they are prepared
to pay, transport operators may also use predatory pricing in order to achieve an objective of
higher proﬁt in the long run.
Predatory pricing
Predatory pricing is said to occur when a ﬁrm, normally with market power in more than one
market, reduces its price below cost in the short run so as to obtain abnormal proﬁt in the long
run. Predatory pricing is aimed at either achieving or maintaining a monopoly situation, with the
price set so as to bankrupt competitors, ‘encourage’ them to merge or in fact collude. Clearly, the
market power comprises barriers to entry, since a failure to prevent new entry would make it
diﬃcult for the operator undertaking predatory pricing to raise their prices once an incumbent
Figure 8.5 Price discrimination in two different markets
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THE PRICING OF TRANSPORT ACTIVITIES
operator had been removed from the market. Thus whilst the consumer may beneﬁt in the short
run from lower prices, such activity may not be in the public interest in the long run.
While it would seem relatively straightforward in theory to show that predatory pricing has
occurred (by ascertaining whether the price charged is below average variable cost), in practice
it can be very diﬃcult to prove that such an activity has taken place. For example, small ﬁrms
may accuse larger ﬁrms of predatory pricing when in reality it may be no more than robust
competition based upon lower operating costs. Where the confusion can occur is in the allocation
of costs between diﬀerent aspects of operation in larger ﬁrms. This results in it becoming
very diﬃcult to establish the actual average cost for a particular aspect of the ﬁrm’s business,
and thus in turn it becomes very diﬃcult to prove that a ﬁrm is pricing at below the average
cost. Predatory pricing is an appealing strategy in a segmented market. The reason for this is
that the dominant ﬁrm is able to impact a rival ﬁrm without changing the prices it charges in
other markets that it serves. Because of the destructive eﬀect of predatory pricing, it is illegal in
most developed countries. Thus in Britain, for example, it can result in investigation by the
competition agencies, such as the Competition Commission, and if a case of predatory pricing
found to be proven will result in the imposition of severe ﬁnancial penalties. Some of the
issues surrounding predatory pricing are developed further in Case study 8.2, which surrounds
acquisitions against EWS, the main British rail freight company, of predatory pricing and other
anti-competitive practices.
Case study 8.2 EWS and predatory pricing
EWS (English,Welsh and Scottish Railways) has been at the centre of a number of accusations
of predatory pricing, two of which are highlighted in this case study – one which was upheld and
one for which it was cleared. This case study attempts to develop the ideas outlined in the
chapter with regard to predatory pricing and more general anti-competitive practices.
Case 1 – The heavy haul sector
EWS is the main heavy haul operator in the UK, and by far the largest rail freight company in
Britain.A major part of its business is in coal haulage,and for this Enron Coal Services (ECSL)
acted in the role of a freight forwarder and offered customers in the sector end-to-end services
in the transportation of coal. It thus acted both as a partner for EWS (for the business with
which it contracted EWS as the rail haulier) and as a competitor to EWS (for the business it
contracted with other rail freight operators).In early 2001 Freightliner bulk,the other main rail
freight company in Britain, entered the heavy haul sector of the market in direct competition to
EWS, having previously concentrated on the market it inherited on privatisation, namely the
carriage of containers. Between February 2001 and August 2002 EWS became the subject of
a number of referrals to the industry regulator, the Ofﬁce of the Rail Regulator (the ORR), in
respect of its coal haulage operations. In particular, some of its actions in the market came into
question and the issue arose as to whether this constituted ‘fair’ competition or was action in
contravention of UK and EU competition laws. Speciﬁcally, EWS was accused of:
᭿ Discriminatory pricing practices in relation to ECSL by offering selective price reductions
to various customers. These rates were signiﬁcantly lower than quoted by ECSL for
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THE PRICING OF TRANSPORT ACTIVITIES
the same ﬂows. This severely compromised ECSL’s competitive position, particularly its
ability to offer end-to-end services to some of its customers.
᭿ Predatory behaviour towards Freightliner. The ORR found that EWS had offered
prices to two electricity generators that were signiﬁcantly below its average costs for
these ﬂows.
᭿ Exclusive contracts – several power generator customers were required to sign longterm
supply contracts with EWS (in one case up to a period of ten years),in which part of
the contract was an exclusivity clause in which the contractor could not engage other rail
freight companies in the haulage of coal. These came in different forms, thus in one case
it was a straightforward exclusion clause,in another a discount scheme was offered which
was dependent upon continued use of EWS services, and the third in the form of a
minimum annual payment which represented around 60 per cent of the contractor’s
haulage requirements.
The ﬁne imposed on EWS by the ORR was £4m; however, similar to the OFT’s ‘leniency policy’
highlighted later in this chapter, this represented a 35 per cent ‘discount’ due to EWS’s cooperation
in the investigation.
Case 2 – Chartered passenger trains
A second case involving EWS was referred to the ORR in 2003 which surrounded the passenger
charter market. For information, although principally a rail freight operator, EWS is the main
owner and operator of locomotives in Britain because all of the British passenger rolling stock
is of the multiple car or trainset variety. Its services are thus in demand for one-off type
operations such as tourist trains on the West Highland line in Scotland that require the hauling
of passenger coaches. The complaint against EWS highlighted a number of issues:
a) EWS had offered prices to certain customers that were signiﬁcantly below its published
terms and that these were designed speciﬁcally to undercut the prices offered by a
competitor.
b) EWS had offered certain concessions on its usual terms of trade to speciﬁc customers,
conditional on those customers continuing to deal exclusively with EWS – these concessions
were, in effect, also designed to exclude a competitor.
After its investigation and review of the ‘factual’ allegations contained in the complaints, the
ORR found that in this case it had no grounds to conclude that EWS had engaged in predatory
pricing or anti-competitive behaviour. Interestingly, very little information surrounds this case,
and hence the actual reasons behind the ORR decision are not clear. It may have, for example,
found that EWS did indeed have a degree of exclusivity clauses, but these may have been based
upon the start up costs of providing these services to particular customers and thus EWS was
simply ensuring recovery of these costs rather than engaging in anti-competitive behaviour.
In many respects what this case study shows is actually nothing at all, but that in itself
underlines the difﬁculty with predatory pricing and issues surrounding anti-competitive
behaviour. It also stresses the point raised in the main text that whilst in theory predatory
pricing may seem quite straightforward, in practice there is a very narrow line between what
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constitutes competitive market behaviour and what constitutes anti-competitive behaviour. For
example it could be argued that the key objective of any ﬁrm is to either eradicate the competition
that exists or protect its current market position by preventing any potential competitor
from entering that market. As in sport, however, the competition should be won through fair
means and not foul, and hence the ‘best’ competitor succeeds. The two cases in some ways show
where this dividing line lies, with in the ﬁrst case exclusivity contracts simply being designed to
keep the competition out. In the second (which we can only speculate on), if similar exclusivity
contracts were found these were in place for a different reason – to ensure recovery of costs, for
which any rival operator could have put an initial bid in to run these services.
An alternative strategy to predatory pricing is for an operator to collude with a competitor,
ﬁxing a price which is in the interests of both operators, but works against the public interest.
Price ﬁxing1
Firms in oligopolistic markets such as the airline sector often face a dilemma as to whether to
compete with each other in order to increase their market share and hopefully their proﬁts or to
collude. Collusion allows ﬁrms to act as a monopolist with the aim of maximising their joint
proﬁts. There are clearly beneﬁts from collusion not least in that by agreeing on what price to
charge or what market to serve organisations can reduce the level of uncertainty. Competition on
the other hand can lead to price wars, predatory pricing or retaliatory action from which all
organisations could ﬁnd their proﬁts reduced. Formal collusion whereby all ﬁrms in a market are
part of a cartel means that they are acting as a single monopoly as in Figure 8.6.
In the ﬁgure demand is the industry demand curve and the marginal revenue curve represents
the summation of the marginal costs of the ﬁrms operating in the cartel. The proﬁts of the cartel
are maximised since MC=MR and they are providing Q output which is sold at a price of P.
Figure 8.6 Cartel based proﬁt maximisation
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THE PRICING OF TRANSPORT ACTIVITIES
Price ﬁxing is one such collusive activity, a situation where ﬁrms within a market agree on the
price they are going to sell their goods or services at in order to remove price competitiveness and
thus increase their proﬁts. In such a situation organisations could compete in terms of non-price
factors such as the level of service oﬀered or the routes served rather than in terms of price. This is a
feature which can be found in oligopolistic markets and can represent a situation in which an
organisation might think that if it increases its price other organisations will not follow and it will lose
market share. We saw an example of this in Chapter 7 which led to the kinked demand curve. If,
however, all the organisations in the cartel agree to set a particular price (whilst demand may be
reduced) all organisations may beneﬁt through an increase in revenue if demand is price inelastic. As
such, price ﬁxing is a form of collusion which enables organisations to increase their proﬁt levels, but
it can be seen to act against the public interest since the organisations are behaving as if they were a
monopoly. As with predatory pricing, therefore, active collusion (as opposed to tacit collusion – see
Chapter 7), in most developed countries, is against competition legislation and thus is illegal.
Collusion by organisations is more likely to occur if:
᭿ There are only a few organisations operating in the market
᭿ The organisations trust each other, so that the agreement reached is not reneged on
᭿ The organisations have similar costs and as such are likely to agree on the proposed price
change
᭿ The organisations provide similar products so there is little scope for competition based on
the quality or level of service
᭿ The market is fairly stable in that neither demand nor costs are changing dramatically. If they
were, then agreement on the price to charge would be diﬃcult
᭿ There are barriers to entry into the market such that new ﬁrms will ﬁnd it diﬃcult to
penetrate the market in order to take advantage of the increased proﬁts.
Collusion can take a number of diﬀerent forms with members of the cartel agreeing on courses
of action such as: what price to charge or level of output to set, what customers to supply or what
discounts to give.
Collusion is diﬃcult to prove since it is usually undertaken in secret behind closed doors, is
often informal and the discussions are verbal.
Case study 8.3 BA price ﬁxing
Introduction
In August 2007 the Ofﬁce of Fair Trading (OFT) ﬁned British Airways £121.5m for illegally
ﬁxing fuel surcharges levied on its passengers undertaking long-haul ﬂights. The ﬁne, which
represents 1 per cent of BA’s turnover, was the result of investigations by the OFT (which began
in June 2006) into collusion between BA and Virgin Atlantic in terms of setting fuel surcharges
over the period August 2004 to January 2006. BA and Virgin are said to have discussed
or informed each other about their proposed changes to fuel surcharges, as opposed to
independently setting levels which is required by Competition Law over that period.Competition
Law forbids ﬁrms agreeing prices since competition is seen as a prerequisite for cheaper goods
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THE PRICING OF TRANSPORT ACTIVITIES
and services for consumers. Fuel surcharges on passengers were introduced in May 2004 as
a way of aiding airline operators offset the rising cost of aviation fuel and have subsequently
become a signiﬁcant component of the price of an airline ticket. This case study seeks to outline
BA and Virgin Atlantic’s anti-competitive price ﬁxing behaviour.
The Competition Act 1998
Under the Competition Act 1998 organisations are prohibited from entering into agreements,
practices and conduct which could be damaging to competition in the UK.In addition to this the
Enterprise Act 2002 gave the OFT additional powers in order to investigate people suspected of
price ﬁxing.
The OFT leniency policy grants immunity from penalties for reporting particular categories
of infringement of the Competition Act and for assisting the OFT in its investigation. The
ﬁnancial penalty depends on such things as how serious the infringement is and the turnover of
the organisation and can be as much as ten per cent of their worldwide turnover.
Price ﬁxing of fuel surcharges
The investigation of BA price ﬁxing was undertaken by the OFT alongside the US Department
of Justice who were investigating allegations of illegal price ﬁxing on air cargo long haul fuel
surcharges. Over the period August 2004 to January 2006 the fuel surcharge of BA and Virgin
Atlantic increased from £5 to £60 for a long haul return ticket.
It can be quite difﬁcult to distinguish between price ﬁxing which is illegal and legal price
setting that constitutes price leadership. In this case of fuel surcharge price ﬁxing, Virgin
Atlantic contacted the OFT in order to report the collusive activity and as such escaped a ﬁne
itself since under the OFT ‘leniency policy’ it was granted immunity.
Price ﬁxing in terms of the fuel surcharge is said to have taken place on a number of
occasions as spelt out in Table 8.2
Table 8.2 The price ﬁxing activity
Date The collusive activity
...........................................................................................................................................................
August 2004 BA and Virgin Atlantic exchanged information on the 6th August 2004
regarding the intentions of their respective organisations to increase the fuel
surcharge (FS). BA told Virgin Atlantic of its intention to increase its FS to
£6. On 9th August both announce an increase in their FS to £6 with effect
from 11th August 2004.
October 2004 BA understands that there may have been attempts by Virgin Atlantic to
contact BA prior to the second increase, but these were not successful. BA
announces an increase in its FS on 8th October to £10. On the same date
Virgin Atlantic announced a corresponding increase in its FS to £10.
March 2005 In two sets of calls on 21st March BA and Virgin Atlantic exchanged
information concerning proposed increases in their respective organisations’
FS. On 21st March Virgin Atlantic announced an increase in its FS to £16
with effect from 24th March. On 22nd March BA announced the same price
increase in its FS with effect from 28th March 2005.
June 2005 BA informs Virgin Atlantic on 23rd June that it is going to announce an
increase in its FS to £24. On 24th June 2005 BA announced an increase in
its FS to £24 with effect from 27th June. That same day Virgin Atlantic
announced the same increase in FS to £24.
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It is unlikely that the ﬁxing of the fuel surcharge undertaken by BA and Virgin Atlantic will
have led to joint proﬁt maximisation as outlined but the collusive price ﬁxing activity is however
likely to have increased their proﬁt margins,otherwise it would be a futile exercise.It is however
a risky activity, as shown by BA’s experience since it is illegal and liable to ﬁnancial penalty if
exposed.
The whole episode reﬂects negatively on the reputation of BA and Virgin Atlantic. In saying
this, the ability to claim immunity acts as an incentive for any sector to police itself, to the
beneﬁt of the consumer.
So far this chapter has dealt with pricing with respect to public transport, detailing the possible
practices of price discrimination, predatory pricing and price ﬁxing. What follows relates to
pricing in terms of private transport, which in many respects is a far more complex area.
PRICING OF PRIVATE TRANSPORT SERVICES
The pricing of private transport services, namely, cars, vans, motorcycles and the like, is multifaceted
as stated above, being paid via a combination of mechanisms starting with the purchase and
licensing of the vehicle, the purchase of fuel; and running costs and also a range of taxes most
notably Vehicle Excise Duty and Fuel Duty. In various locations there is also road user charging in
operation, most notably in Central London and further a ﬁeld in Singapore and Stockholm. These
prices can be seen placed under various headings as illustrated in Figure 8.7.
Acquisition costs
Acquisition costs are those incurred when a vehicle is obtained. These refer to the purchase price
of the vehicle including VAT. The private motorist will typically ignore these costs when underTable
8.2 — continued
Date The collusive activity
...........................................................................................................................................................
September 2005 On the 5th September Virgin Atlantic informed BA that it intended to
increase its FS and be the ﬁrst to announce the increase on this occasion. On
6th September 2005 Virgin Atlantic announced an increase in its FS to £30
with effect from 7th September. On 8th September BA announced an
increase to £30 with effect from the 12th September 2005.
November 2005 On 18th November Virgin Atlantic informed BA that it was about to
announce a reduction in its FS to £25. Shortly afterwards Virgin Atlantic
announced a reduction to £25.
January 2006 On 6th January Virgin Atlantic informed BA that it intended to increase its
FS to £30. Later that day Virgin Atlantic announced an increase in FS of
£30. BA did not change its FS in response.
Source: Adapted from Times Online (2007)
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THE PRICING OF TRANSPORT ACTIVITIES
taking an individual trip, but they can be substantial particularly when new vehicles are involved.
There can be other acquisition costs involved in certain countries such as car purchase tax and the
Certiﬁcate of Entitlement which is a system in use in Singapore.
Car purchase tax is to be found in most EU countries and is paid in addition to VAT on new cars
bought. Car purchase tax of 10 per cent was abolished in the UK in 1992 and replaced by an
increase in fuel duty. This was a move welcomed by the motor industry who had long canvassed for
its abolition regarding it as a discriminatory tax applying only to cars, with all other consumer
goods being only subject to VAT.
The Certiﬁcate of Entitlement (COE) is a system used in Singapore in order to limit car
ownership and as such the number of vehicles on the road. The system requires Singaporean
residents to bid for the right to purchase a vehicle, with a limit placed on the number of COE.
Typically, COE bidding starts on the ﬁrst and third Monday of each month and lasts for three days.
There are various categories as seen in Table 8.3. A bid can be submitted anytime during the threeday
process with a reserve price being the maximum that the bidder is prepared to pay for a COE.
If the current COE price is above the bidder’s reserve price then the individual will be out of the
bidding unless they revise their reserve price. It is important to note that the reserve price can only
be revised upwards and not downwards. Clearly this is to prevent bidders from submitting an
initial bid for a COE which is somewhat higher than they would actually be prepared to pay. In the
event of an unsuccessful bid then the bid deposit will be credited to the bidder’s bank account.
As can be seen in Table 8.3 6,038 bids were received by the Land Transport Authority in the
second open bidding at the end of August 2008. Of these approximately 80 per cent (4,800) were
successful. The non-transferable COE are linked to speciﬁc vehicles, but both the COE and the
vehicle can be sold to a new owner. In terms of Transferable COE they can be changed from
vehicle to vehicle. As can be seen, the Quota premium ranged from $14,001 for Category E to
$1,310 for Category D.
Figure 8.7 Charges incurred when undertaking a private transport journey
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THE PRICING OF TRANSPORT ACTIVITIES
Periodic costs
These can also be called standing charges and are the basic costs of owning a car for use on the
roads network. They refer to charges that have to be paid whether or not the car is used and as such
include the annual registration tax (Vehicle Excise Duty) and insurance.
The majority of developed countries operate an annual registration tax, called vehicle excise
duty (VED) in the UK. In the majority of cases this is related to the power of the car or engine size
but in a number of cases, including the UK, it is linked to addressing environmental issues and to
encourage fuel eﬃciency. This can be seen in Table 8.4 below with a range of VED Bands based on
carbon emissions, with band G being the highest emitting band in 2008–09.
In the UK vehicles which are more than three years old require a Ministry of Transport (MOT)
test each year. This is to ensure that the vehicle complies with a minimum road safety and
environmental standard. There are various test fees depending on the type of vehicle, but at the
time of writing, the fee for a car with up to 8 seats is £53.10.
Table 8.3 August 2008 second bidding exercise for certiﬁcates of entitlement
Quota
premium
Total bids
received
Number of
successful bids
....................................................................................................................................
Non-transferable categories
Category A (Cars 1600cc and below, and taxis) $13,289 2,318 2,036
Category B (Cars 1601 and above) $13,890 1,362 1,071
Category D (Motorcycles) $1,310 548 445
Transferable categories
Category C (Goods vehicles and buses) $12,989 492 370
Category E (Open) $14,001 1,318 878
Source: Land Transport Authority (2008)
Table 8.4 UK vehicle excise duty rates (£12 month rate), 2008–09 (for private vehicles
registered from March 2001)
VED band CO2 (g/km) Petrol and diesel cars Alternative fuel cars
....................................................................................................................................
A 100 and below £0 £0
B 101–20 £35 £15
C 121–50 £120 £100
D 151–65 £145 £125
E 166–85 £170 £150
F 186–225 £210 £195
G* Over 225 £400 £385
Source: Directgov (2008)
Note: *For cars registered on or after 23 March 2006.
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THE PRICING OF TRANSPORT ACTIVITIES
Fixed costs per trip
The ﬁxed costs which may be incurred by those undertaking a journey include parking charges
whether that be public on-street, through pay and display or oﬀ-street in public or privately
owned car parks.
The journey may also involve a river crossing for which a charge or toll is made. For example at
the time of writing the tolls shown in Table 8.5a and b were in operation at two such river
crossings in the UK:
Road pricing is designed as a measure to reduce congestion (see Chapter 3). As such, it will
impact on the price of a journey, since it represents a charge for the use of road space. There are a
small number of schemes worldwide including the Electronic Road pricing scheme in Singapore
and the congestion charging schemes in Stockholm and Central London. Case study 8.4 considers
the London congestion charging scheme in more detail.
Case study 8.4 Central London congestion charging
The ﬁrst major congestion charging scheme in Britain was launched in Central London in
February 2003, the aim of the scheme being to reduce congestion.
Motorists entering the congestion charging zone between the hours of 7am and 6pm
Monday–Friday (excluding public holidays) are charged £8. 700 video cameras enforce the
scheme via the scanning of the rear number plate of the vehicles that enter the area during
the charging period. The information obtained is matched against a database of motorists each
evening in order to ascertain who has paid the charge.Payment can be made via the Internet,by
phone or at shops or petrol stations.If the motorist has failed to pay the charge before midnight
a ﬁne of £100 is imposed and if the offender pays within 14 days then the ﬁne is reduced to £50.
In relation to the charge certain groups are exempt or given a discount from part or all of the
charge:
Table 8.5a Severn River crossing westwards toll only
Vehicle Category 1 (Up to 9 seats) £5.30
Vehicle Category 2 (Small bus up to 17 seats, Goods vehicles up to 3500KG) £10.60
Vehicle Category 3 (18 seats and more, Goods vehicles from 3500KG) £15.90
Table 8.5b Dartford River crossing: charges in operation 0600–2200
Between 2200–0600 charges are £1.00 for each category
Motor Car: including Motor Car with three wheels or taxi £1.00
Light or Medium Goods Vehicle: Motor Coach, Omnibus or tractor: having more than two
axles
£1.80
HGV, Motor Coach or Omnibus or Tractor having more than two axles £2.90
Special Type Vehicles £2.90
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THE PRICING OF TRANSPORT ACTIVITIES
᭿ Certain vehicles receive a 100 per cent discount including alternative fuel vehicles,
namely those powered by an alternative fuel, bi fuel or dual fuel, and not solely by petrol
or diesel. They are exempt on environmental grounds but must also meet strict emissions
criteria.
᭿ Blue and orange badge holders are also exempt.
᭿ Certain NHS staff, patients and emergency vehicles (police vehicles, ﬁre engines, and
ambulances) are exempt.
᭿ Certain vehicles such as those with more than 9 seats and two-wheeled motorbikes
(and sidecars), mopeds, black cabs licensed with the Public Carriage Ofﬁce (PCO) and
mini cabs licensed with the PCO are also exempt.
Advantages of the scheme
᭿ Congestion in urban areas can be viewed as market failure with the actions of road
users in Central London affecting other road users. Congestion has a cost associated
with it not least in terms of the increased time taken to undertake a journey and the
opportunity cost that involves. The charge is aimed at reducing congestion, thus freeing
up the road network and so reduce the time taken to complete a journey.
᭿ Economics is concerned with the optimum use of scarce resources and since road
space in Central London can be viewed as a scarce resource then charging for its use will
mean that it can be used more efﬁciently.Thus those that value the time most will pay the
charge.
᭿ The revenue raised from congestion charging is to be used to improve the alternatives,
namely, public transport.
᭿ Individuals tend not to like being charged and as such the use of regulation has tended
to be more acceptable. The use of regulation however tends to be a ‘blunt instrument’,
something which cannot be ﬁne tuned to tackle varying demand conditions and unlike
congestion pricing it produces no revenue.
᭿ Encourages efﬁcient transport systems in terms of land use space, i.e. mass movers of
people.
᭿ Unlike measures such as enhancing public transport services in the area, one major
advantage with a congestion charge is that the charge can by varied at very short notice.
It is therefore very ﬂexible.
᭿ In simple terms it works. If set at the right level, a congestion charge will impact on
congestion.
Disadvantages of the scheme
᭿ Clearly one issue with congestion charging is the invasion of privacy given that the
system relies on taking a photograph of vehicle number plates.
᭿ The charge can be viewed as a regressive measure as those who pay the charge and
are on lower incomes pay a larger proportion of their income than those on higher
incomes in order to drive in central London. In order to negate this claim, the use of the
revenue generated from the scheme is all important. If the revenue is used to subsidise
and enhance public transport as an alternative to the car, then the charge can be seen as
more equitable.
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THE PRICING OF TRANSPORT ACTIVITIES
᭿ The cost has been seen as a disadvantage. It has been estimated that the cost of
setting up the scheme has been £200m and it costs an additional £80–90m to operate
per year.
᭿ The scheme utilises a rather simplistic technology. Namely cameras on all the roads
into the central area and a ﬁxed price of £8, the charge not changing in line with the level
of congestion experienced. This may however change over time and as the scheme evolves
it could see the use of global positioning satellites (GPS) and cars ﬁtted with satellite
receivers in order to allow a charge to be made based on distance, time and location.
᭿ Ideological argument – in urban areas individuals already pay for the roads through
local taxes, hence why should they pay again?
Variable costs per trip
The last main item shown in Figure 8.7 is the variable costs per trip. These are costs that are
incurred on each trip and which vary in accordance with one or more of the characteristics of the
trip. For example, trip length, trip destination, timing of the trip and traﬃc conditions. The major
element of this cost relates to fuel.
In addition to VAT fuel is subject to fuel tax, called Fuel Excise Duty, which is charged as a rate
per unit of fuel, i.e. per litre/gallon (Potter 2008). The rate will diﬀer depending on the type of
fuel, whether it be petrol, diesel, LPG or low-sulphur.
The fuel duty rates vary across the European Union, thus impacting on the retail price, as seen in
Table 8.6.
Table 8.6 Retail price of premium unleaded petrol and tax (2008)
Tax as % of retail price Retail price (Eurocents per litre)
....................................................................................................................................
Netherlands 64 1.69
Denmark 62 1.58
Germany 65 1.57
Finland 64 1.57
Italy 61 1.54
Belgium 61 1.53
France 64 1.51
United Kingdom 67 1.51
Portugal 60 1.50
Sweden 63 1.47
Irish Republic 57 1.34
Austria 56 1.33
Luxembourg 54 1.32
Greece 47 1.27
Spain 53 1.23
Source of data: Potter (2008) based on www.aaroadwatch.ie/eupetrolprices/ (accessed 12.08.08) and Transport
Statistics Great Britain, 2007, Table 10.8.
Note: This data covers all tax on petrol (including VAT).
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THE PRICING OF TRANSPORT ACTIVITIES
A change in the tax structure?
There has been a debate in the UK about the potential implementation of a national road pricing
scheme although this seems unlikely at the present time. If it were to be seriously considered then
one of the key issues would be the type of technology used. It would need to be ﬂexible enough to
charge based on time, distance, and place as well as being able to target the environmental costs
(DfT 2004). The motoring taxes as outlined above are not able to match that of a national road
pricing scheme in terms of sophistication in addressing the issue of congestion when and where it
occurs (DfT 2004) – but then this is not the prime function of motoring taxes.
If a national road pricing scheme were to be introduced then important decisions would be
required in terms of whether it should replace fuel duty – whether in whole or in part. If it were to
be totally replaced then it would require a change in European law. Equally, it would not be
possible to abolish fuel duty until the whole country was operating distance charging.
CHAPTER SUMMARY AND REFLECTION
This chapter has examined the issues surrounding the pricing of transport services. In a free
market economy, the price is set by and large by the type of market structure, and hence is
generally determined by the forces of demand and supply. As will be seen later in Chapter 10, in
mixed markets the price is a combination of the market and intervention by transport authorities
in the form of regulating the price and/or capacity. This chapter has therefore considered
‘deviations’ from these two positions in order to gain a better understanding of pricing issues
in transport markets. Firstly therefore price discrimination was introduced as this is an important
aspect of public transport pricing being extensively utilised by bus, rail and air operators.
The aim of price discrimination is to increase the operator’s proﬁts by eroding the passengers’
consumer surplus. Airline operators, in particular, have been astute when it comes to price
discriminating with respect to price or practising yield management – charging varying prices
to their customers with diﬀering time-sensitive elasticities in order to increase the number of
seats sold. It should also be noted however that price discrimination may be used by public
transport authorities to better manage the demand for a given transport system and thus
spread the demand for the service across a larger time range. In addition to price discrimination
public transport operators have been known to use predatory pricing, charging a price
below cost as a means of undercutting competitors in order to create a monopoly situation. An
alternative strategy to predatory pricing is one of price ﬁxing, where operators collude, ﬁxing
the price at an artiﬁcially high level, in order to increase proﬁt. An example is given of airline
price ﬁxing of fuel surcharges between 2004 and 2006. Both measures however are illegal as
they are anti-competitive and act against the public interest. Finally, pricing of private transport
services has been detailed, being multifaceted in nature, with acquisition, periodic, ﬁxed
and variable costs.
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THE PRICING OF TRANSPORT ACTIVITIES
CHAPTER EXERCISES
Exercise 8.1 Price discrimination
Figure 8.8 refers to a rail operator that is practising price discrimination, charging a different price to
the passengers in market 1 compared to those in market 2. It is assumed that costs are constant,
therefore MC = AC.
a) What does Figure 8.8 reveal about the type of passengers using the service and their relative
elasticities?
b) Calculate the abnormal proﬁt earned by the rail operator by price discriminating.
c) Based on the information presented in Figure 8.8 sketch out the diagram for the rail operator
if it were not to price discriminate.
d) Are there any beneﬁciaries from price discrimination and what happens to consumer surplus
when price discrimination is practised?
Exercise 8.2 Pricing behaviour
Transport operators in oligopolistic markets practise predatory pricing and price ﬁxing from time to
time. Outline what you perceive to be the beneﬁts to transport operators of such practices and the
reasons why they are illegal in many countries world-wide.
Figure 8.8 Price discrimination in two rail markets
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THE PRICING OF TRANSPORT ACTIVITIES