Transportation Economics

Despite the fact that NAFTA was passed under the leadership of a Democratic president, it became a contentious issue in the race for the Democratic primary of 2010: Barak Obama said he opposed the basic principles of NAFTA, while Hillary Clinton supported them. NAFTA has been one of the most controversial trade treaties in recent memory, despite the fact that it has been estimated to have increased U.S. GDP by as much as .5% a year. NAFTA eliminated trade barriers in critical areas of international commerce: for example, Mexican agricultural products, which were once subject to heavy tariffs, became much cheaper for American consumers (Amadeo 2010).

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Imported oil from Mexico and Canada became much cheaper for the U.S. — and thus NAFTA reduced U.S. dependence upon Venezuelan and Middle Eastern oil. It increased foreign direct investment by guaranteeing foreign investors had the same legal rights as local investors and eliminated barriers related to services in healthcare and the financial industries, thus increasing the flow of knowledge between nations. However, NAFTA also had substantial disadvantages: it drove down the price of American labor, given that wages were far lower in Mexico and American companies could more easily expand their operations across the border. Additionally, Mexican farmers struggled to compete with heavily government-subsidized American corn, soybeans, and other products (Amadeo 2010).

Q2. Despite the ubiquity of the American automobile, the energy crisis of the 1970s combined with the environmentalist movement and traffic congestion drove many urban areas to try to incentivize the use of public transportation. However, this move to going ‘car free’ was far from problem-free (Murga, 2002, pp. 10-11). Every major transit project was announced as “the solution” to users’ reluctance to give up daily car use (Murga, 2002, p. 16). But urban life is constantly changing: the number of commuters who must rather than choose to use public transportation, population growth, and the financial feasibility of extensive government investment will all shape how transportation projects are viewed. Additionally, convenience, safety, and affordability for the user must be balanced in an often uncomfortable equation. Finally, the environmental and social impact of mass transit projects on residents must be evaluated, to ensure the continuing good will of the people, especially if construction is a lengthy process. The long-term nature of most projects can easily thwart community generosity, if residents see all of the negatives of construction but none of the benefits of enhanced transportation.

Q3. Southwest Airlines was famously proclaimed to be ‘nuts’ — plane crazy, was its slogan, because of its low fares. It was able to adopt such a business model by ‘thinking small.’ Instead of offering a wide range of amenities, Southwest offered bare-bones service — no meals or fancy pillows and blankets. Everyone was treated as an equal — everyone effectively ‘flew coach.’ Also, the carrier for many years remained stubbornly regional in its orientation and focused on serving lower-cost, less trafficked airports that had lower wait times, to minimize delays on connecting flights as well as airfares. “In 1971, air travel was a luxury business, but Southwest’s founders went bargain basement. They cut overhead by flying only one model of plane, operating out of cheaper, second-tier airports and minimizing the time their planes spent languishing in airports (by doing away with logistical headaches such as assigned seating and complicated meal service)” (Messing with success, 2007, LA Times).

Other carriers adopted the opposite technique: United Airlines and American Airlines focused on business travelers and offering extra amenities to individuals who flew first class. Such major carriers hoped to secure loyalty from frequent fliers with generous rewards packages. However, when the fortunes of the airline industry soured in the wake of fears of terrorism after 2001, and the subsequent recession, such an exclusive, segmented business model no longer proved effective for the major carriers. Yet Southwest’s low-cost formula was far from foolproof. When fuel costs spiked, making bargain-basement fares impossible, Southwest found it difficult to compete with other budget carriers such as JetBlue on price. “Southwest can no longer streamline its way to competitive advantage. To stay on top, it needs more revenue. So it’s setting its sights on business travelers, who typically pay more for a ticket but who also demand flights from mainstream airports, easier boarding and more generous loyalty programs” (Messing with success, 2007, LA Times).

This suggests that the major carriers are becoming more ‘like one another.’ But as the economy wavers and technology enables businessmen and women to use virtual, rather than face-to-face meetings, focusing on either a low-end or high-end strategy is problematic. Southwest can generate fewer cost savings as fuel costs rise and the numbers of vacationers plummet. More airlines are adopting its ‘nuts only’ service, diluting the image of its unique brand. However, luxury service is less in demand, given the still-shaky nature of the economic recovery.

Q4: “Traditionally, the effects of tax policy on firms’ demand for investment are summarized in estimates of the ‘user cost of capital.’ The user cost of a capital investment is the minimum return a firm needs to cover depreciation, taxes, and the opportunity costs of the funds used to finance the project. Lower user costs typically translate into higher investment levels,” thus reducing taxes can stimulate investment by reducing the user cost of capital (Gale 2010). However, depreciation of investments for items such as facilities and machinery is inevitable, and will extract some toll upon the firm, no matter what the tax rate. “Almost every business must invest in some major equipment, vehicles, machinery, or furniture in order to operate” on a regular basis (Capital assets, 2003, Complete Tax).

In contrast to the user cost of capital, or depreciation estimated upon a per-project basis, “major assets that will be used in your business for more than a year are known as capital assets” or “assets that have a useful life of more than one year” (Capital assets, 2003, Complete Tax). Measuring depreciation in terms of capital assets requires taking stock of depreciation that takes place over time, rather than on a per-project basis. From an accounting standpoint capital assets are written off for more than one year, and the costs of depreciation are measured over the course of the years the entity uses the capital asset: depreciation may be measured regularly on a year-by-year basis, or may increase as the use of the asset depreciates more quickly from year to year.

Q5&6: If energy prices fall, the input costs of providing transportation will reduce for the firm, thus increasing the firm’s profits if demand remains the same. In the short run, firms will respond to the fall in energy prices by increasing their services and possibly decreasing fare prices, to increase profits. In the long run, however, the market will begin to ‘level out,’ as there may be more market entrants, thus increasing the supply of the item and driving down the price to an unprofitable point. There is also a limit to how much a firm can produce, given its current assets. Eventually, the law of marginal utility will mean that it will become too costly to over-expand its offerings to the public and the level of demand will not justify such an expansion.

(Source: Nobilis 2010)

Fuel prices tend to be relatively inelastic: it is difficult, if not impossible, for the consumer to eliminate the use of transportation-related costs entirely. There is also a limit to how many transportation services the public can consume, even if they chose to fly more in the wake of decreased fares in the short-term. Other constraints will limit traveling, thus the truism that all constraints on behavior are costly. As there is a limit to how much the average vacation or business traveler can increase or decrease his or her travel, the short-run total cost curve lies above the long-run total cost curve, and the long-run costs resembles more ‘level’ behavior in the wake of the inelasticity of fuel demand.


Amadeo, Kimberly. (2009, December 20). Facts about NAFTA.

Retrieved April 21, 2010 at

Capital assets and depreciation. (2003). Complete Tax. Retrieved April 21, 2010 at

Gale, William G. (2010). Deficits, interest rates, and the user cost of capital: A reconsideration of the effects of tax policy on investment. The Brookings Institution. Retrieved April 21, 2010 at

Messing with success. (2007). LA Times. Retrieved April 21, 2010 at

Murga, Mikel. (2002, September 6). Urban transportation planning MIT Course 1.252j/11.380j

Retrieved April 21, 2010 at

Nobilis, Lauren. (2010). Price elasticity. Biz Development. Retrieved April 21, 2010 at

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