(2024) A Level H2 Econs Paper 2 Essay Q2a

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Why fixed costs of owning a new car in Singapore are considerably higher than the variable costs

Fixed costs are costs that do not change with the level of usage. For car ownership in Singapore, these fixed costs include the need to obtain a Certificate of Entitlement (COE) under the Vehicle Quota System (VQS) and the Additional Registration Fee (ARF) imposed by the government. The COE is a significant cost, averaging around $100,000 in the last 2 years (2023-2024), and is required to own a car for 10 years. This fee reflects Singapore's efforts to control vehicle population by limiting the number of vehicles on the road.

The ARF is another major fixed cost, calculated as a percentage (ranging from 100% to 320%) of the car’s Open Market Value (OMV). These taxes are payable as a one-time fee at the point of purchase and do not vary with the number of kilometres driven or trips made. Together, these policies make Singapore one of the most expensive countries in the world for car ownership, with total fixed costs easily reaching five to ten times higher than in most other nations.

In contrast, the variable costs associated with car use, such as fuel expenses, parking charges, and routine maintenance, vary with the level of usage. For instance, fuel costs depend on how frequently the car is driven, and parking charges are incurred based on the time spent at specific locations. These variable costs are relatively low compared to the significant fixed costs imposed during the purchase phase, making the fixed costs the dominant financial consideration for car owners in Singapore.

The disproportionate burden of fixed costs is a direct result of Singapore’s VQS and ARF policies, which are designed to manage traffic congestion and limit environmental externalities by discouraging excessive car ownership.

Why this is likely to lead to greater car use

The sunk cost fallacy provides a key explanation for why higher fixed costs often result in greater car use. The sunk cost fallacy refers to the irrational tendency to consider past, irrecoverable expenditures (sunk costs) when making current decisions, even though such costs should not influence rational decision-making.

In Singapore, car owners who have already paid significant sums for the COE and ARF may feel compelled to maximise their usage of the car to "justify" these sunk costs, even though those costs are irrecoverable. For example, a family that has spent $200,000 on fixed costs may be more likely to drive the car frequently instead of using public transportation, even if public transit might be more economical or convenient for certain trips. This behaviour occurs despite the economic principle that sunk costs should not influence rational decision-making; only future costs and benefits should matter.

Moreover, the mindset that “I’ve already paid so much for the car, so I should use it more” becomes particularly prevalent in Singapore, where the cost of a new car can be five to ten times higher than in other countries. This behaviour leads to the overutilisation of vehicles, increasing road congestion and environmental externalities, even though policies like the VQS and ARF were intended to reduce these issues.

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