'It's brilliant - I am being rewarded not to use my car'

These are the words of Londoner Michele Chung who has taken out an insurance policy that is tailored to where she drives, when she drives and how far she drives. Economics is all about understanding how incentives and disincentives affect human behaviour. In this chapter, among other things, we are looking at how demand for a good or service is affected by a range of factors, the most important of which is price. This price relationship gives rise to the law of demand that tells us that quantity demanded moves in the opposite direction to price. So what is it about Michele's insurance policy that relates to the law of demand? Michele's car is fitted with a GPS device that tells her insurance company when, where and how far she drives every day. This information, taken in conjunction with the insurer's knowledge of the risks of having an accident in different places at different times, enables the company to charge Michele a different insurance tariff for every day depending on how she is using her car. Michele then adapts to these charges accordingly. So, if Michele can cycle to work on some days, she pays a very low premium on those days because the only risk of damage to her car is as a result of it being stolen or run into while it is stationary. This is why Michele says she's being rewarded for not using her car. From the economist's perspective she's simply responding to the incentive to save on her insurance - responding to price according to the law of demand. Similarly, Michele may choose not to drive on a notoriously unsafe stretch of road if she knows that she will be paying a significantly higher premium to do so. In an article in the Financial Times, journalist John Reed points out that such a system of charging for insurance has enormous benefits for older, infrequent drivers and people who use their cars only on the weekends.[1] In relation to younger drivers who have very high accident rates at night, the high night-time premium discourages their use of cars at this time, resulting in fewer deaths and injuries among this accident-prone group. And why wouldn't younger drivers respond to this incentive when the insurance rate is 20 times higher at around $2.60 per kilometre at night compared to 13 cents per kilometre in the day? There is the potential for everybody to benefit from time-of-day pricing for insurance. With accident rates at morning peak times being 50 per cent greater than on weekends and in the evening, the higher premium for this time would result in some drivers avoiding morning peak travel, so reducing the amount of congestion on already busy roads. Insurance policies like Michele's, which are sometimes called pay as you drive (PAYD) policies, are now available in many countries including the US, Australia, South Africa, Japan and Canada. This type of policy is continually evolving. For example, some PAYD insurers now require the on-board, or smartphone, installation of telematics devices which can measure driving habits relating to vehicle speed, acceleration, braking and cornering.[2] You can see that driving behaviour can be made to respond to the risk of accidents at different times of day and in different places. But, of course, this will only happen if demand for these types of policies grows. At the present time most car insurance policies involve a flat-rate premium that is charged regardless of when and how often the policyholder uses their car. It is easy to see that once the annual flat-rate premium has been paid, the cost of insurance per kilometre goes down the more kilometres you drive. In fact, the additional insurance cost for an additional kilometre driven - what economists call marginal cost - is zero. When the price at different times of day and in different places. But, of course, this will only happen if demand for these types of policies grows. At the present time most car insurance policies involve a flat-rate premium that is charged regardless of when and how often the policyholder uses their car. It is easy to see that once the annual flat-rate premium has been paid, the cost of insurance per kilometre goes down the more kilometres you drive. In fact, the additional insurance cost for an additional kilometre driven - what economists call marginal cost - is zero. When the price paid for additional time spent driving on roads is zero it is no wonder that once the annual premium has been paid, there is no incentive, in terms of insurance cost, to switch to cycling as Michele does because of her use-related insurance policy.

Using the information provided, answer the following questions:

If Michele uses her car less at night because the insurance premium at this time is higher, does this involve a change in demand for car travel or a change in quantity demanded?

If drivers such as Michele find that their annual insurance cost is significantly lower as a result of the implementation of the new system, is there likely to be an increase or increase in demand for motor cars as far as these drivers are concerned?

If the price of pushbikes were to increase tenfold, would people like Michele be likely to use their car more or less, ceteris paribus?