Tuesday, 22 October 2013

Market competition and firm costs in the taxi industry

I've been in Wellington the last couple of days, presenting at the Pathways, Circuits and Crossroads Conference (more on that later). Anyway, I had a quite interesting conversation with my taxi driver on the way into the city from the airport, which I thought I should share.

This semester, my ECON110 students showed some scepticism over the mechanism/s through which costs increase when a market becomes more competitive. The standard explanation relates to economies of scale (smaller firms have higher average costs because the fixed costs such as administration, etc. are spread over a smaller quantity of output). However, my conversation with the taxi driver raised another potential explanation.

Some four or five years ago, the taxi industry in Wellington was deregulated. Prior to that, my driver says, special licenses were required in order to operate a taxi (possibly similar to taxi medallions in New York, but without the resale market). After deregulation, the number of taxi operators exploded - he wasn't sure of the exact numbers, but they may have doubled or more. The result was a large increase in competition in the market.

How does that increase in competition raise costs for taxi drivers? Of course, it doesn't materially affect direct out-of-pocket costs like fuel, taxi maintenance, etc. However, it does affect the cost-per-fare, through time (opportunity) costs. The explanation goes like this. Before de-regulation, there were fewer taxis. When a driver arrived at the airport with a fare, he could expect to wait a relatively short time before picking up a new fare, so faced only a small time cost for each fare. With a large increase in the number of taxis competing for fares, taxi drivers now wait much longer at the airport before collecting a new fare (my driver said that he had waited over 90 minutes before picking me up. This isn't unusual, or specific to the airport - he said there were often similar waiting times at the city taxi stands). This increases the opportunity costs for each taxi driver, since they could be doing something else with that time (like this, perhaps?), raising the costs per fare.

Anyway, that provides another alternative explanation for why costs might rise as competition increases - competitive firms must work much harder to attract customers, and working hard is costly.
Coming back to the Pathways conference: If anyone is interested, a video of my presentation on Subnational Stochastic Population Projections in New Zealand will soon be available on the Nga Tangata Oho Mairangi research project website. From the feedback I have received, my presentation was most memorable for my opening statement that "All population projections are wrong" (paraphrasing a quote from the British mathematician George E.P. Box). For more context on the wrongness of Auckland population projections recently, see here for example.

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