Increasing consumer surplus through price increases

By Seamus Hogan 07/05/2013

As I noted last year, the University of Canterbury administration has this
year increased the price of an annual parking permit threefold from (roughly)
$100 to $300. This raises the price from what was a subsidised rate to
something they calculate as being approximately marginal cost. Needless to say,
this is something that the Economics department had been advising for a long
time, given our propensity to value efficiency even at the expense of our own
direct wellbeing. After a few months of experience with the new policy, it has
become clear, though, that it is not only efficiency enhancing, but it has also increased
consumer surplus even without consideration of what use the university makes of
the increased revenue.

How can that be? It is an application of how the deadweight loss
triangle in a standard S&D diagram understates the cost of a price floor or
ceiling. Previously a parking permit at Canterbury did not confer a right to
park; it conferred the right to hunt for a park. Many of us wasted a lot of
time searching for a park before giving up and parking on the street several
blocks away. The problem was particularly acute on wet days. Some of those who successfully found parks had a low willingness
to pay, others who missed out valued the parks much more highly. How do we know
this? Well this year, as a result of a trivial price change from
next-to-nothing to three times next-to-nothing, the carparks are never full.*
Even on the wettest days, one can come in late and always be guaranteed a park.
Those cluttering up the parks last year but not this clearly didn’t value the
parks highly; this year, it is only those put a high value on parking who get
the parks. And how high can that value be. Well we don’t know for sure, but I
am sure this story could be replicated here.

So there we have it. The price went up, and so did consumer surplus.
Could the same happen in reverse. Well imagine if you were to impose average
cost pricing in the retail electricity market despite it being an industry with
sharply increasing marginal cost. Everyone would get a lower price for power,
but with no guarantee that the lights would come on on demand. Consumer surplus
might well go down. And that is without even considering the lost government
revenue from publicly owned power companies….

* I find it difficult to comprehend the size of the demand response; think
of the Slutzky equation: there is a huge shortage of on-street parking around
the university, so there are no close substitutes for on-campus parking;
$300/annum is hardly a large fraction of anyone’s expenditure, student or
lecturer. Can the income elasticity really be that high? 

0 Responses to “Increasing consumer surplus through price increases”

  • An interesting thought. I have two queries. Firstly, it isn’t clear your example meets the test of ceteris paribus. Were student and staff numbers the same in each year, for example? Secondly, what about the consumer surplus of the people who didn’t buy the $300 tickets? You haven’t considered this. They may be happier to save the parking fees and take a bus, walk or car-pool, but we don’t know.

  • You wrote :
    “$300/annum is hardly a large fraction of anyone’s expenditure”

    Does the way that this is paid have any bearing ? Some people may be able to scrape together $100 to pay for parking, but not manage to get together $300. So even though they would be better off with the parking, the entry price has barred them from participating.

    Now that there are always empty car parks, does this show reduced efficiency, since the resource is under-utilised. When they calculated the $300 price this may not have been taken into account, so the funds they receive do not cover the costs. So next year they put the price up further, and then more people drop out. Clearly, this is not an optimum outcome.

    • You can also get a $9 one-day parking pass. I keep a few in the glove box of our second vehicle for days when we need to take two cars.

      I’ll disagree that empty car parks are evidence of inefficiency: knowing that there will be space to park has value.

  • surely this is an incredibly inefficient pricing model. After all, the first car parked each day has a huge amount of choices in an empty carpark – the last relatively few, and probably is late too.

    Airline pricing would seem more appropriate then – early parks are cheap to help fill the spaces and sell a rapidly decaying product, late or short lead time parks much more expensive to extract maximum revenue from the small remaining number of parks.

    The supposed efficiency of the one price system is in fact incredibly inefficient in no small part because it assumes the motivation for every driver is the same. Its inefficiency is at least identified (if not acknowledged) in the statement that the carpark is never full…

  • I would have thought an idea would be to take back all the parking permits in. Now multiply the number of permits by the $$$ previously charged. Lets say the admin want another 10%. Then add that to the total. Decide on a number of permits to issue (say no more than 2% to 5% more than the number of parking areas. Sell them at Total cost divided by parking spaces.

    Of course you couldn’t possibly limit the number of parking permits. People might sell them and make a profit. Tut tut.

    Or maybe a Bitcoin model. The first park is free and gradually increase the price exponetially that makes the last one VERY expensive. Say, at least twice the price of the second to last one. Breakeven point (income) could be aimed at about 90% full. Or whatever the breakeven point is for a bit of aleady laid tarmac is. Tarmac would be difficult to value as an asset.

    Or. The parks could be saved for those staff and students who have a measure of disability. Then open the rest to the parking permit system. After all, close parks could be termed a convenience, be useful, or a commodity. I prefer the useful.

  • @ Possum: Eric raised the issue of a general demand shift on the original post at Offsetting Behaviour. Student and staff numbers are down by about 15% this year, but off-street parking is also down (causing an offsetting effect) and it seems that the total response has been much more than 15%, so at first glance the price elasticity is very large.

    The lost consumer surplus is somewhere between $0 and $200 for each consumer who would have bought a permit at $100 but chose to not do so at $300. We don’t know how large the gain in consumer surplus is to those who bought at $300 but at $100 were not able to get the park they valued at more than $300. It is not a given that total consumer surplus has increased, but it is not unlikely.

  • @Brent: From the point of view of maximum efficiency, the parks are overpriced, since the empty spots are a wasted resource. And yes, the calculation of the cost of a carpark was based on total cost divided by #parks (that is average cost) when efficiency requires price=MC. AC pricing in a world of decreasing average cost can lead to exactly the sort of crazy dynamics you mention.
    But relating the permit price to cost might just have been a PR exercise, where what the University really wants to do is maximise monopoly profit.