Tag: marginal cost

Charging for parking

In a potentially interesting move, the Delhi government has declared that starting from 2016, only half the stock of Delhi’s cars will be allowed on the road each day, based on the parity of the number plate.

While in theory it might work, the dependence of Delhi people on cars, ownership of multiple cars and possible number-trading might render it moot. Also, given that not everyone uses their car every single day, a simple car swap arrangement (like Zipcar; but we need to figure out liability properly) might defeat this regulation.

The more sure-fire way to reduce the number of cars on the road is to impose a congestion surcharge but it it is not an easy regulation to implement – given that you’ll need electronic modes to collect tolls, devices in cars, etc (not that it hasn’t been done, but given India’s scale it’s considerable effort).

A better way to implement congestion surcharge is to charge economic rates for parking. In most cities in India nowadays, parking is highly subsidised (in terms of money) which results in more people taking their cars out, not being able to park them, and creating further congestion by driving around looking for a place to park (Brigade Road in Bangalore is a good example of parking-led congestion thanks to slow-moving cars looking for a place to park).

The question is what an economic rate for parking must be, and that can be determined by looking at the prevailing real estate rates in that area. In the area I live in Bangalore, for example, the “guidance value” (rate used by the municipal corporation to determine the “fair value” of a property in order to tax sales) is about Rs. 8000 per square foot.

Assuming a price to earnings ratio of 20, this translates to Rs. 400 per square foot per year, or little more than a rupee per square foot per day. A parking lot is about 9 feet wide and 18 feet long (based on US standards, assuming India is the same). Let us assume a 50% overhead for space needed to move the car in and out of the lot. Based on this, the “fair rent” for one car parking space in my area is 18 * 9 * 3/2 * 400 / 365 = ~Rs. 270 per day, or translates to around Rs. 11 per hour.

Notice that all the calculations above were either multiplications or divisions, and hence the per hour parking price is directly proportional to the guidance value of property in the area. Based on the numbers above, a good rule of thumb for “economic cost” of an hour parking space is 11 / 8000 or about 14 basis points (a basis point is one hundredth of a percentage point) of the per square foot guidance value.

Of course, there are transaction costs (of putting the car in and out) and demand varies by time of day (so we might have an element of “surge pricing”). Yet, what we have is a good rule of thumb to decide the per hour parking rates.

Pricing and waiting in line

Every time I have to stand in what seems like an exceedingly long line for something, I wonder if they’ve got the pricing wrong. If they had their economics straight, I reason, they would raise prices to an extent where the market just “clears”, and there is no need for a line.

In this context, this piece by Tyler Cowen comes in handy, where he talks about the various advantages of lines and waiting in line. Apart from some superfluous stuff such as lines making us more patient and waiting in line being less painful now thanks to smartphones, Cowen makes some very interesting points. For example,

Higher prices also skew the customer mix toward wealthier and thus older people, who exert less influence over the purchasing decisions of their peers. They are less likely to text about a concert, put it on their Facebook pages or talk up its reputation to dozens of friends at parties. The younger buyers are usually the ones who make places trendy, thus many sellers use lower prices, with lines if need be, to lure in those individuals and cultivate their loyalties.

The above passage illustrates why it is sometimes necessary to keep prices lower than the “clearing price” and let lines form (as long as you have an orderly way of dealing with the lines). Essentially, by raising price until a point where the market just clears, you are optimising the revenues for that particular day or point in time.

However, if you are a “going concern”, as all businesses are normally assumed to be, you don’t optimise for revenues or profits on a particular day. What you optimise for is long-term sustainable profit, and you do what it takes in order to maximise that.

As Cowen says above, by keeping prices lower than clearing price, you draw crowds that are likely to talk about the experience of your offering, thus giving you free advertising. As the “flash sales” conducted by Xiaomi (where phones sold out in a few seconds after sales opened) show, lines can end up being reported in the press which creates free publicity for you – leading to greater future sales.

Then there is (Cowen touches upon this) the signalling effect of the line itself – that so many people are waiting in line for something signals that there’s something inherently worthy about the product, and results in increasing demand (and more people in the line!). The line is an act of discovery – you may not go to a food card if you didn’t see the line in front of it.

There is also the issue of price elasticity – beyond certain levels, prices can be extremely elastic, in that if you raise prices at a particular margin, demand drops significantly (this has to do with “price barriers” in people’s minds – possibly a behavioural issue). So it becomes impossible for you to set the price at the precise level where your establishment just fills up. So you have a choice between not filling up your capacity or getting people to stand in line. And the latter is more profitable.

The lesson from this is that you should think long term when you are analysing pricing decisions, and not optimise for maximising instantaneous profits! Read the full piece by Cowen. It’s well worth it.