Transportation Economics Research Paper

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To begin, transportation economics covers a broad range of issues. There are differences between personal and freight transportation, among transportation modes, and between the fixed and variable parts of the transportation system. Analysis of personal transportation tends to focus on commuting and choice of mode, although there is also substantial interest in other personal transportation choices, such as time of day for travel and grouping of trips. For freight, the issues are primarily related to the cost of freight movement and the damage that heavy vehicles do to roads. Each mode has similarities and differences in the issues to be analyzed. For virtually all transportation systems, there is a large, typically publicly owned, infrastructure and a variable, often privately owned, set of vehicles that use that infrastructure (Dean, 2003). The financing systems are often complex, and the incentives that they offer may generate further issues that need to be addressed in evaluating transportation systems.

In discussions of transportation, there is near universal agreement that there are problems. Each mode has different problems. For automobiles, increasing congestion, difficulty in financing construction and maintenance, and concern over the environmental effects are major issues. For public transportation, a long-term downward trend in share and rising costs are the key concerns. For freight, competition and cooperation among the modes, capacity of the freight system, and allocation of cost are among the important topics.

This research paper starts with a discussion of the demand for transportation services and the factors that are important in analyzing the choices made from the perspective of the user of the transportation system. Then, of course, supply of transportation is evaluated. Because the market for transportation services is not the typical market system, the method of funding and the incentives for efficient use of the system are then discussed, along with the role of government in regulating the transportations system. The research paper concludes with a discussion of some of the important policy debates regarding transportation.

Demand for Transportation Services

The trend for personal travel has been for increasing use of the automobile and reduced reliance on alternative modes. One result has been increased levels of congestion and delay on the road system and increasing subsidies for the transit system. From an economic perspective, many of the perceived problems occur because people do not pay the appropriate price for travel. Hence, it is important to understand the demand for transportation and the methods of finance because the latter determines the perceived price.

There are two important distinctions between the demand for transportation and the demand for most goods and services. The first is that transportation is typically classified as a derived demand; most travel is not consumed for itself. Rather, it is a method to achieve other goals. The second is that for personal transportation, the person’s time must be used, and the value of this time is part of the cost of transportation. Thus, time and the value of time are very important issues in discussions of transportation. In fact, transportation economists often differentiate between the cost of transportation services and the cost of transportation, which includes the opportunity cost of the time used in making the trip. The latter is typically referred to as generalized cost. This distinction is very important when analyzing the demand for transportation services because the differences in time cost often have substantial impacts on the choice of mode for travel.

The next step in analyzing the demand for personal transportation refers to elasticity of demand. In addition to the common discussion of price elasticity of demand, the income elasticity of demand and cross-price elasticity of demand are important in analyzing transportation choices.

Cost and the Value of Time

The most common example of the distinction between the generalized cost and the monetary cost of different choices is the choice of mode for commuting. If one looks only at the monetary cost, then mass transit would be a bargain, compared to driving, for most people. The transit fare is typically a fraction of the cost of using an automobile, especially if the person driving must also pay for parking. Despite the price differences, the vast majority of commuters in the United States choose the automobile over mass transit. A major reason is that the auto commute is typically much shorter than the transit commute, and people value the time savings. A broad generalization often used in transportation analysis is that people value time in commuting at about half of their wage rate, but there is substantial variation in people’s willingness to pay to save time. This valuation also varies by how the time is being used. Time spent waiting for a transit vehicle costs more than time spent in the vehicle, and time spent driving in congestion is viewed as being much more costly than time driving at free flow. More recent research also finds that there is considerable variation across individuals in the value they place on time (Small, Winston, & Yan, 2005).

Another aspect of the value of time is the reliability of the system. Although average travel time is very important, the variation in travel time may be equally important to many people. Getting to the destination either early or late may impose costs on the traveler. The cost might be being late for work or a meeting, or it might be having extra time before work starts. The greater the variation in travel time, the more of a cushion is needed to be reasonably certain of getting to the destination at a specific time. One method of describing this is to look at the probability distribution of trip times. For example, the average trip time may be 20 minutes, but because of wide variation in congestion, the traveler may have to leave 30 minutes before the desired arrival time to have a 90% probability of arriving on time. In general, higher levels of congestion are associated with higher levels of uncertainty in addition to the longer travel time. This may make it difficult to identify the value of time for the traveler, and there is evidence that people place a separate value on improved reliability compared to reduced travel time (Lam & Small, 2001).

Time is also of importance in freight transportation, although it is typically less a factor than for personal transportation choices. Some items are perishable, so the value of time is obvious, but the use of overnight express and similar services show that saving time in the movement of freight can also be valuable. In addition, many firms have come to rely on timely delivery of inputs as a method to reduce the need to hold large inventories of the items that they use in the production process. Because late delivery can disrupt the production process, both time and reliability are important for these freight services.


There are a variety of elasticities that are important in understanding transportation economics. The price elasticity of demand is the one most commonly discussed in economics, and it is very relevant for transportation. However, two other elasticities are important in analyzing transportation choices: the income elasticity of demand, which relates to changes in demand as income changes, and the cross-price elasticity of demand, which relates to the way demand for one good changes when the price of another good changes.

Price Elasticity

For transportation, the price elasticity of demand is complicated because there is either the ordinary price elasticity of demand, based on monetary price, or the generalized cost elasticity of demand, based on monetary and time cost. Where the time needed for travel does not change, the ordinary price elasticity of demand is evaluated. In general, the price elasticity of demand for transportation is fairly low in the short run; people do not appear to be overly sensitive to price in deciding whether to make a trip. For example, the general rule of thumb is that the price elasticity of demand for transit is about 0.3. Hence, a 10% increase in transit fare is expected to lead to a 3% reduction in the number of riders. However, the estimates of the elasticity of demand cover a wide range (Holmgren, 2007). Elasticity of demand for a particular mode or at a particular time may be higher or lower than the average because there will be different opportunities to substitute other modes, routes, or times, and the availability of substitutes makes demand more elastic. A variety of other price elasticities are sometimes discussed, such as the elasticity of demand for gasoline. The elasticity for gasoline is found to be very low in the short run (Congressional Budget Office, 2008), but this is largely because the cost of gasoline is only a part of the cost of the trip. Any given percentage increase in the price of gasoline will be a much smaller percentage of the cost of the trip, and the full cost of the trip is the more relevant consideration.

Income Elasticity

Another very important elasticity is the income elasticity of demand. It compares the change in the demand for a good or service at fixed prices with the change in income. The demand for most goods and services is expected to increase with income. However, if the demand decreases as income increases, it is labeled an inferior good. Generally, inferior goods are goods that have a higher quality substitute available, and as income rises, people shift to the higher quality substitute.

In transportation, one sees that the demand for automobiles is highly income elastic. Both within countries and across countries, one sees rising demand for automobile ownership as income rises. This, of course, affects the demand for using transit, which is typically seen as an inferior good. There are many factors other than income that affect the demand for different types of transportation, but the general trend is consistent. The demand for more transit increases over some income ranges, but over most levels of income, the demand for transit decreases as income increases, everything else constant.

Cross-Price Elasticity of Demand

Another important elasticity concept is the cross-price elasticity of demand. It refers to how the demand for one good changes when the price of another good changes. This is the typical method to identify complements and substitutes. If the price of one good rises, people tend to use less of it. If as a consequence they buy more of some other good, that other good is a substitute. However, if the goods are complementary, then the reduction in the purchase of one good would also lead to a reduction in the purchase of its complements. Transit advocates argue that providing more transit services or reducing transit fares would reduce the number of automobile trips. This is an argument that the two are substitutes, and the amount of substitution then depends on the cross-price elasticity of demand. This is an empirical parameter, and it will differ among areas and over time. The evidence in the United States is that in most cities, the cross-price elasticity of demand between transit and automobiles is very low, if not zero. This means that lowering transit fare does very little to get people out of their automobiles. As noted earlier, the price elasticity of demand for transit is fairly low. This implies that lowering fares is not extremely effective in getting people to use transit, and some of the increase in transit usage is caused by an increase in trips taken or diversion from other modes, for example, carpooling, walking, or biking, rather than a diversion from trips in automobiles.

The other factor of importance with respect to cross-price elasticity is the relative shares of the substitutes. For example, if transit carries 10% of the trips and automobiles carry the other 90%, then even if all new transit trips represent a shift from automobiles, a 10% increase in transit usage (to 11%) would decrease auto use by only about 1% (to 89%). This means that transit-oriented policies are likely to have noticeable effects on auto use only in areas that already have large amounts of transit use.

Supply of Transportation Services

Just as the analysis of the demand for transportation had to take account of the unique characteristics of transportation services, the supply analysis is affected by them as well. Much of transportation infrastructure is large scale. In the United States, roads, transit, and airports are typically provided by the public sector, although there is increasing interest in private ownership and provision. Economies of scale in providing the infrastructure and the combination of passenger and freight transportation are two of the more important issues in the supply of transportation services.

Economies of Scale

Economies of scale relate to the relationship between the cost per unit and the number of units being produced. Economies of scale are often important in transportation, but the focus is typically somewhat different than for most goods and services. For example, mass transit requires many users for it to be cost effective. However, there are different ways to measure scale; one is simply system size, and the other relates to service over given segments of the system. The distinction is between the size and the density of the network. Density relates to the number of people wanting to make a particular trip, typically from a common set of origins to a common set of destinations. As more people want to make the same trip, the cost of providing that trip per person is often reduced, although the range of scale economies may be somewhat limited. If one considers simply the size of the system, then adding more routes would increase scale, but it is less likely there will be economies of scale using this measure.

In addition to the number of people wanting to make essentially the same trip, one also must consider the options that are available for a trip. In this case, the network becomes an important consideration. The network refers to the places that one can get to on the transportation system. For the automobile, the network is essentially any place that has a road, but for other transportation systems, the network is typically much more constrained. For a mass transit system, one might consider the network to be simply the areas within easy walking distance of stations or stops.

Another way to think about network effects is to consider each trip as composed of three separate functions. These are typically defined as collection, line haul, and distribution. First, the passenger must get to the transportation system. Then there is typically a relatively high-speed movement to some other point in the system, from which the traveler must get to the ultimate destination. For air travel, the three functions would be getting to the airport, the plane trip, and then getting to the ultimate destination. For commuting by car, each segment tends to be done in the vehicle, although there may be a walk to the vehicle at the beginning and the end. For transit, the collection phase may involve simply walking to a transit stop, but it may also involve driving or biking to a transit stop or using a feeder service to get to the main transit stop. Historically, collection was typically associated with walking to transit, and many residential areas developed around streetcar or other transit services. Once the passengers are on the transit vehicle, the majority of the distance is covered. This may be on local service or some form of express service. Finally, when the passengers leave the transit vehicle, they must get to their destination, typically by walking.

Economies of Scope

Another issue in the cost of providing transportation services is the ability to provide different types of transportation services. Using the same facilities to provide different types of transportation service is called economies of scope. The largest distinction in this area is between personal transportation and freight transportation. For example, both automobiles and heavy trucks typically use the same roads. This makes sense only if there are economies of scope in the provision of roads, and most studies conclude that this is indeed the case. In other words, it would be possible to have a separate network of roads for trucks and for automobiles, and occasionally there are such separate facilities. However, they are rare. There are disadvantages of mixing automobile and truck traffic on the same road. For example, roads must be built to higher standards to withstand the damage done by heavy vehicles, so a road built solely for automobiles could have thinner pavement. Safety concerns, speed differences, and the discomfort some drivers feel near large vehicles are also associated with mixing the vehicles. On the other hand, there are benefits to mixing the traffic. Roads with two lanes in each direction can carry more than twice as many vehicles as roads with only one lane in each direction because they allow easier passing and other operational improvements. Separate roads would also have to have separate fixed costs, like shoulders. It also seems that there are some benefits related to time of usage, with automobiles having more usage during peak congestion periods and trucks often showing greater flexibility to use the roads at less congested times (de Palma, Kilani, & Lindsey, 2008).

Passenger rail and freight rail are much less compatible. For passenger rail service, time is very important, but for freight rail service, the emphasis is on keeping the cost low. Hence, freight trains are often large and slow moving. Because it is difficult to pass another train, passenger and freight traffic tend to interfere with each other. If the volume of traffic is low, the economies of scale in sharing track may make combined service the least costly option, but as volume increases, the diseconomies of scope typically cause separation of the activities.

Mode Choice

Mode choice is important both for personal travel and for freight movement. Mode choice for commuting has received substantial interest because of the growth in the share of single-occupant vehicles and the decline in share for transit, carpooling, and other modes. Although the mode shares differ substantially across countries, the trend tends to be fairly universal. To some extent, this is the result of rising incomes and people placing a higher value on saving time, but there are also substantial concerns about whether people are making those choices based on full information regarding the cost differences.

Location Patterns

If one thinks about the commute in terms of the collection, line haul, and distribution phases, it becomes apparent that changes in location patterns over time have had a substantial impact on the ability of transit to serve these functions for commuters. As population decentralized, development moved away from concentration around transit stops, but transit could still serve effectively if people could get to the system and employment was concentrated around transit. Hence, park and ride became a viable option for people with a car available. The increased ownership of automobiles over time made this a possible method to use transit for many people. However, the decentralization of employment has proven to be more problematic. Although people are willing to take cars that were purchased primarily for personal use and let them sit in a parking lot while at work, they typically are not willing to purchase a car to be used to get from the transit station to work. Hence, a commuter often can still use transit if his or her residence is not located near a transit stop, but it is more difficult if his or her employment is not near a stop. Hence, employment location patterns have become an important issue for the viability of using transit.

Components of Cost

Another important consideration in mode choice is the cost perception on the part of the person making the decision. Economic theory tells us that the efficient decision depends on the decision maker’s facing of the full marginal cost. However, it is seldom the case that the person making a commute decision will face that cost. The distinction between fixed cost, marginal cost, and external cost is helpful in understanding the potential distortion. In making a decision between auto and transit commuting, the person is likely to take account of both fixed and variable costs, but once the choice to use an auto is made, only variable costs enter the decision for a particular trip. Further, certain costs may be paid indirectly or by someone else and will not enter into the decision.

If one does not own a car for other reasons, then the full cost of purchase and maintenance will enter into the mode choice decision. Once the automobile is purchased and other fixed costs, such as insurance, are paid, only the variable cost of using it for a particular trip will be taken into account. The income elasticity of demand for automobiles has affected the relative cost of using transit and cars based on the marginal cost comparison. As income increases, people who are transit users may still find that the automobile is very convenient for recreation and household use. Yet once the vehicle is purchased, the cost of using it for commuting is only the variable cost, and this will shift the commute mode choice decision. There have been some experiments associated with converting some fixed cost of auto use into variable mileage costs to see how behavior would change (Abou-Zeid, Ben-Akiva, Tierney, Buckeye, & Buxbaum, 2008), and people do seem to drive less when the mileage charge is higher (Rufolo & Kimpel, 2008).

Aside from the difference between fixed and variable costs, automobile users, especially at peak times, do not pay all of the cost associated with automobile usage. Some costs are simply paid indirectly or by others. Parking is often cited in this category because relatively few employees pay for parking at their places of work (Shoup, 2005). Other costs are paid by the drivers, but those costs do not reflect the full marginal cost. Congestion falls into this category because the cost of increased delay with congestion is imposed on drivers, but the marginal cost of one more driver exceeds the average cost paid by the driver. This complex subject is covered in detail in a later section. Finally, automobile usage generates substantial negative externalities in the form of pollution and related costs, and these costs are not paid by automobile users (Parry, Walls, & Harrington, 2007).

Transit users typically do not face efficient prices either. Large subsidies keep the fare charged substantially below the marginal cost of providing service, although a later section shows that there is some disagreement about the optimal transit subsidy. Peak-period transit fares typically should be higher than off-peak fares to reflect the fact that the need for capital stock is determined by the peak usage. In addition, fares should be higher for longer trips, and there should be a variety of other adjustments to reflect cost differences. Few transit agencies follow any of these principles, so commuters by transit also tend to pay substantially less then the optimal charge. One effect of the pricing system is that there is likely to be too much consumption of all transportation services relative to the optimum.


Road congestion is a significant and growing problem in most countries. Economists typically define the effect of congestion as an external effect of using the transportation system. There are actually several different causes of congestion. The first relates to bottlenecks. Bottlenecks reflect a reduction of capacity. A reduction in the number of lanes can certainly create a bottleneck; however, in transportation, they can occur for a variety of reasons. For example, places where traffic enters and leaves a limited-access road may have reduced capacity even though the number of lanes is unchanged, and the bottleneck is defined by the reduction in capacity. Next, there is congestion caused by incidents. These may be accidents or simply stalled vehicles or animals on the road. Finally, there is systemic congestion. This occurs based on the number of vehicles trying to use a road, and it can best be thought of as an effect that each driver has on all other drivers. For safety, there must be some distance between vehicles. As more vehicles try to use the same road, the distance between vehicles becomes compressed. The crowding forces traffic to slow. Because the slowing is associated with the number of vehicles on the road rather than some vehicles slowing others, it is typically analyzed as being caused equally by all users of the road.

Economists have concluded that there is a substantial difference between the additional time that each driver must take and the effect that having one more vehicle on the road creates for the whole system. To help see this, consider the following example. Suppose that if 1,000 cars per hour try to use the road, there is completely free flow, and each driver takes 10 minutes to complete his or her trip. However, if 1,001 cars per hour try to use the road, the slight slowing causes each driver to take 10 minutes and 1 second for the trip. The total travel time for 1,000 cars is 10,000 minutes, but the total travel time for 1,001 cars is slightly more than 10,026 minutes. Thus, although each driver sees a travel time of a little over 10 minutes, the total travel time for all drivers has increased by over 26 minutes. Because any one of the drivers could reduce the total by 26 minutes by not making the trip, it is clear that none of them are considering the full effect that their using the road has on the entire system.

Congestion Pricing

The effect of most types of congestion is that the cost to individual drivers is less than the cost to the system. As the example shows, someone who values the trip enough to make it if the time cost were as high as 15 minutes would, if faced with the full 26-minute cost imposed on the system, decide not to make the trip. Economists propose that all drivers be charged the difference between the cost that they face and the cost that their use of the system imposes on the whole system. This is known as congestion pricing.

It can be formally demonstrated that the idealized system of pricing would generate net benefits for society through more efficient use of the road system. However, drivers have been strongly opposed to such pricing systems. The basic reason is that to make the system work, most drivers must be made worse off than they are with the so-called free system. It may seem paradoxical that there is an improvement if most drivers are worse off. The reason is that under congestion, drivers pay with time, but under a toll, they pay with money. The time that they waste in congestion is a cost to them but provides no benefit to anyone. The toll that they pay is also a cost to them, but it is just a transfer of money to the toll agency. This money can be used to lower other taxes or provide additional benefits. Hence, the individual drivers are worse off, as they are with any tax or fee, but the transfer of money allows for some offsetting benefits to be created, while the wasting of time does not.

There are a variety of types of congestion pricing. State Route 91 (SR91) in California has two lanes in each direction that are priced and four lanes in each direction that are unpriced. The price is changed as often as every hour, but the rates are set in advance. The disadvantage of prices set in advance is that the demand for using the road varies randomly to some extent. The prices that are set in advance may have to be high on average so as to generate free flow most of the time. This could lead to less usage than would be efficient. With the fixed charges, drivers then have the choice of paying and saving some time or not paying and facing congestion. Studies of the usage of SR91 find that relatively few drivers use it every day, with many drivers using it occasionally. The explanation is that it may be worth it to save time on some days but not on others, for example, if parents are late to pick up their children.

Interstate 15 in California has two reversible lanes that are free for high-occupancy vehicles (HOV) and charge a price that is varied as frequently as every 6 minutes for other cars so as to maintain free flow. The benefit of the dynamic pricing is that it allows more vehicles to use the lanes in periods of low demand while still maintaining free flow during periods of very high demand. The disadvantage for drivers is that they do not know until they arrive at the entrance what the price will be. The price is displayed on an electronic sign, and they have a short time to decide whether to take the priced road or to stay on the free one.

A number of cities have adopted a system of charging vehicles either for entry into an area or for any driving in that area. Singapore is widely cited as the first city to use this system, but London has received substantial interest for instituting its system. London charges a flat fee for any vehicle that drives within the designated zone and designated times. The fee varies with type of vehicle and for a variety of other reasons, but the basic fee is a flat charge. The fee is enforced with a system of video license plate recognition.

There is one additional drawback to congestion pricing. It costs money to collect and administer the charge. For example, one study of the London system concluded that the cost to administer the system was so high that it offset the benefits from better traffic flow (Prud’homme & Bocarejo, 2005). Reductions in the cost of the equipment needed to impose charges, along with improvements in the administrative capability to collect revenue, cause these issues to decline in importance over time, but they must be taken into account when evaluating the net benefits of using pricing to manage congestion.


Congestion can become so severe that there is actually a reduction in the number of cars that get through to their destinations in each time period. The easiest way to illustrate that would be to think of complete gridlock, the ultimate congestion. In this case, no vehicle gets to its destination. There is some disagreement about when congestion gets bad enough to cause an actual reduction in the flow of vehicles. For many years, it was thought that a speed of about 30 to 35 miles per hour maximized flow, but recent research suggests that flow may be reduced when speeds drop below free flow. Where hypercongestion exists, congestion management has the potential to increase both speed of travel and the number of vehicles traveling (Varaiya, 2005).

Congestion Policy

Although economists recommend pricing that varies by time of day to manage congestion, there is relatively little support for this approach. Most congestion policy relates to other methods to relieve congestion. Congestion caused by too many people trying to use the road can be addressed only by changing their demand to use the road. Pricing is the most effective way to do this, but other types of demand management also can be effective. The most common is the use of ramp metering to manage the number of vehicles entering a restricted access road. Ramp meters can improve the flow on the metered roads, but they have some drawbacks as well. They can cause backups onto surface streets, and they favor vehicles making long trips over vehicles making short trips. Responses to other types of congestion may differ. For example, the best response to congestion caused by incidents seems to be to work to rapidly clear the incident. Many states now have operations to do precisely this. They encourage people in fender benders to move to the side of the road and may have service vehicles to help clear accidents or stalls.

Latent Demand

As the time cost of a trip increases, people make various adjustments to their travel plans. With respect to peak period congestion, the term triple convergence is often discussed (Downs, 2004). Anthony Downs argues that when faced with increased congestion, some people respond by changing their time of travel to less congested periods, others change mode of travel, and still others change the route of travel. Another possibility is to choose not to make the trip. These changes reduce the maximum peak congestion from what it would be if people had not changed their behavior, but it also means that adding capacity has less impact on the maximum amount of congestion than it would if people did not change their behavior. As congestion decreases, people will shift back to their preferred times, routes, and modes. Hence, the triple convergence then offsets some of the benefits of the increased capacity.

With triple convergence, people may now be traveling closer to their ideal times, taking a more direct route, or traveling by a preferred mode, but these shifts then mitigate the effect on peak congestion that the increased capacity generates. To be sure, there are substantial benefits to these shifts, and the period of peak congestion is likely to be smaller. However, some see these shifts and argue that there is no benefit to building additional road capacity because it simply gets used up. They term the increase in usage as being latent demand. Although the convergence of travel times does mitigate the benefits of the capacity expansion, it is a serious mistake to conclude that there are no benefits. Nevertheless, understanding triple convergence and latent demand gives us more capability to accurately predict the impact of transportation investments.

Mass Transit

The long-term trend for transit is a declining share of personal transportation. Most transit in the United States was privately owned and largely funded from fares until about the 1960s. Since then, most systems have been converted to public ownership and rely heavily on public subsidies for funding. Critics contend that this has caused substantial inefficiencies in transit operations (Lave, 1994), while supporters argue that transit provides offsetting benefits. Hence, the important economic concerns are how the organization of transit affects efficiency and the arguments for public subsidies.

Economics of Transit

As noted earlier, two key issues for transit are the economies of density and the network characteristics. John Meyer, John Kain, and Martin Wohl (1965) are credited with first analyzing the relative cost of different methods of urban transportation. They did not consider the value of time, so they were just considering monetary cost. Their conclusion was that the automobile was the low-cost alternative for low density of use and that buses were then the low-cost alternative, except for very high density, when rail would have the lowest cost. Although actual density has increased in most cities over time, the density of transportation demand often has not. The transit system economies occur when a large number of people want to make the same trip at the same time. Decentralization of first residences and then employment has often reduced the density of trips, making transit more costly despite the increase in overall density. In addition, the outward spread of most urban areas has reduced the percentage of residences and places of employment that are within the transit network. Finally, the increased value of time associated with rising incomes has increased the generalized cost of transit relative to auto travel.

The issue of public versus private provision generates substantial controversy. A number of other countries, including England, have moved toward more privatization of their transit systems. In the United States, some transit systems contract with private providers for service. Supporters of privatization argue that the competition leads to lower cost and improved efficiency, and the evidence seems to support this conclusion.

Transit Fares

Transit has peak demand that is similar to that for automobiles. Economists typically argue that prices should be set to reflect the cost of providing the service. From an economic perspective, the cost of providing peak transit service is higher than the cost of providing off-peak service. This seems counterintuitive to most people. The large number of people using the system during the peak means that the cost of running the vehicle is spread over more passengers than in the off-peak hours, but the number of vehicles needed by the system is determined by the peak usage. Thus, more of the cost of the system is attributed to the peak than to the off-peak usage.

The counterargument is that each person who uses transit actually creates a benefit for other users (Mohring, 1972). The basis for this conclusion is that as more people use the system, more service is provided and average wait time decreases. Average wait time for transit is somewhat dependent on the frequency of service. If people arrive randomly at the transit stop, then the average wait is half of the time between vehicles. So increasing the number of vehicles leads to reduced average wait time, and this means that the efficient fare would be lower than the marginal cost of providing the service because as more people use the system, wait time for others is reduced, creating an external benefit that justifies a subsidy. Despite this argument, Charles Lave (1994) finds that the subsidies have largely resulted in inefficient production rather than more service.

Although economists argue about whether subsidies promote or hinder efficiency in transit, the popular argument for transit subsidies is that the lower fare can be used to entice people out of their automobiles. However, the evidence on very low cross-price elasticity of demand between transit and automobiles means that this argument is largely incorrect for most cities.


There is a long history of regulation of the transportation industry. Many types of regulation relate to issues such as safety, but there has also been substantial economic regulation of the various modes. For many years, the federal government set prices for airlines, railroads, and trucks. Although the intent was to protect consumers, the effect of deregulation of these industries has been substantial improvements in productivity and reduction in prices (Winston, 1998). To be sure, many of the improvements are viewed negatively by some. For example, under regulation, railroads were required to maintain substantial amounts of service where the cost exceeded the revenue, but they were then able to compensate by charging higher prices on service in high-demand areas. Under deregulation, prices declined in the high-demand areas, and much of the service to low-demand areas was discontinued. This is an improvement in efficiency, but it is negative from the perspective of those losing service.

Taxi regulation is one area of transportation regulation where there does not seem to be much prospect for reform. Many cities restrict the number of taxi licenses that they grant. From an economic perspective, the restrictions on entry are likely to cause prices to increase and service to be concentrated in the most profitable areas. More competition is expected to improve service and result in reduced prices. Yet experience with taxi deregulation has been problematic. This may be because certain types of competition are not allowed in the deregulated markets. For example, most airports require that passengers take the taxi at the front of the line. There is no opportunity for one farther back to offer the service at a lower price. Hence, deregulation may still not allow much competition. One study concludes that a whole new regulatory structure is needed for all parts of the transit and taxi system (Klein, Moore & Reja, 1997).


Funding for transportation has received substantial attention. For example, Congress created two separate commissions to study and make recommendations on transportation finance: the National Surface Transportation Policy and Revenue Study Commission and the National Surface Transportation Infrastructure Financing Commission. Each concluded that existing finance mechanisms were insufficient and recommended changes. The method of funding and the level of funding are both sources of controversy. In personal transportation, there are disputes about whether auto users or transit riders pay the appropriate costs. In addition, there is substantial concern that both highways and transit face substantial challenges with respect to finance.

Highway Finance

In an economist’s ideal world, prices for vehicles using the road system would be set to reflect the cost the vehicle imposes on the system (Winston & Shirley, 1998). The economic system works most efficiently when price is equal to marginal cost. For cars and other light vehicles, the primary determinant of the efficient price would be the level of congestion on the road in use. Where congestion is heavy, the price would be high, and a low price would be charged for travel on uncongested roads or during off-peak times. The high price would discourage use during the peak (Rufolo & Kimpel, 2008) and induce more use of alternative modes, including carpooling. The substantial decline in the number of true carpools has caused some people to argue that carpooling will not occur because people value their time highly and carpools impose a time cost for formation. However, there has been spontaneous carpool formation where there is an incentive, such as reduced travel time for those in carpools (Spielberg & Shapiro, 2001). The revenue generated from pricing would also serve to guide new investment. Where revenue is high, the value of added capacity will also be high, so the price serves as a sign that more investment should be considered.

For heavy vehicles, the price should vary with the road damage done and congestion. Heavy vehicles do substantially more damage to roads than light vehicles, and the damage is largely related to the weight per axle of the vehicle. Oregon charges a weight-mile tax that varies with both weight and number of axles for heavy trucks, because spreading a given weight over more axles reduces road damage (Rufolo, Bronfman, & Kuhner, 2000); however, most states and the federal government raise road revenues from heavy vehicles through fuel taxes and registration fees. Raising revenue with efficient prices also serves to manage the use of the system. It is expected that efficient management would reduce the amount of road capacity required to meet any level of demand.

In the absence of better management of the road system, there are ongoing predictions of the need for massive investments. Although a pricing system would reduce the required investment as well as generate revenue, the large growth in demand for transportation over time indicates that more capacity will have to be added to the system. How that new capacity will be financed is a contentious issue. Although there is more consideration of pricing and tolling as finance mechanisms, they still represent a small percentage of the existing revenue sources.

Most revenue for the road system in the United States comes from fuel taxes and other charges to vehicle users, although there is substantial disagreement about whether road users pay the full cost of the system. Some of the disagreement comes from disagreement about what is a user cost. Fuel taxes are viewed as user charges by most, but some critics consider fuel tax revenue that goes to road construction and maintenance as a subsidy. More substantive disagreement occurs about items like property tax revenue used for local roads. Some view this as a subsidy for roads while others argue that local roads are primarily of use to local landowners. Other disagreements relate to how general-purpose taxes on vehicles should be counted (Dean, 2003). Virtually all economists agree that vehicles should be charged for the externalities that they generate; however, there is disagreement about what the charge should be (Delucchi, 2007).

Cost allocation studies are done by both the federal government and a variety of states to determine whether different classes of vehicles are paying their proportionate shares of the cost of building and maintaining the road system. This is another area of substantial controversy, but the complexity of the issue precludes going into it in detail here.

Whether vehicles pay the full cost or not, there is agreement that the current method of funding the road system faces serious problems. The fuel tax has been a major source of road finance at both the state and federal levels; however, growing fuel efficiency and the prospect of alternative fuel vehicles raise questions about the adequacy of this source over time. In addition, the tax is typically set at a rate per gallon, so the purchasing power decreases with inflation, and there has been substantial resistance to increasing this tax. Because of the concerns about fuel taxes, there has been increased interest in more directly pricing the use of roads, either with a simple charge per mile (a vehicle miles traveled [VMT] tax) or some form of congestion pricing. An important drawback to these alternatives is the cost of collecting the revenue. As these costs decline over time, there is likely to be more extensive use of these alternative revenue sources.

One effect of improved ability to collect tolls or impose other prices is that it becomes more feasible for private firms to build roads, operate roads, or both. The concern with private firms operating roads is that the price that optimizes the use of the road may not coincide with the profit-maximizing price. Rather than having too much traffic because drivers are not paying the full cost of using a congested road, the road may be underused because of the high monopoly price.

The use of pricing has also raised questions regarding whether uniform pricing is the most efficient approach. HOV lanes are problematic. Their intent is to encourage carpooling, but they often appear to be underused or ineffective. When demand is relatively low compared to capacity, the total vehicle flow may be substantially reduced relative to general use of the lanes. A number of HOV lanes have been modified to allow non-HOV drivers to use them and pay a toll (high occupancy vehicle toll lanes are called HOT lanes). Effectively, solo drivers have the choice of congested but no-charge lanes or paying a fee for better conditions. This raises the question of whether such charging systems are more efficient than leaving all lanes unpriced and whether more than two prices might be efficient (Small & Yan, 2001). Because the value of saving time differs across people and for the same person under different circumstances, a better understanding of this distribution and of the effect of segregating lanes on traffic flow is needed. However, improvements in technology are likely to make complex pricing more feasible over time.


As noted earlier, transit is often criticized for being costly and ineffective, with costs rising rapidly over time and transit’s share of travel declining. The share trend can be affected by items like high prices for fuel, but increased ridership is likely to increase cost more than revenue and place further financial pressure on the system. There seems to be little likelihood of transit in the United States becoming self-sufficient. Hence, the major issue for transit is whether subsidies will keep up with rising costs or whether some changes in the way transit services are provided will improve efficiency (Klein et al., 1997). If congestion pricing is implemented, then demand for transit service will increase and reduced congestion will make bus service less costly and more reliable. Under these circumstances, the economics would argue for higher fares and lower subsidies, but much of the discussion related to making congestion pricing more acceptable to the public regards increasing transit service, as was done in London.


Rapid growth in freight movement has placed strains on various parts of the freight system. The Federal Highway Administration (2007) identifies road congestion, intermodal transfer facilities, and capacity constraints on railroads as important issues. For trucks, the issues are very similar to the ones for automobiles in terms of congestion and financing the roads, although freight concerns are more concentrated on the need for improvements at specific bottlenecks.

Efficient pricing of roads would charge vehicles on the basis of their axle loadings and damage to roads. On the other hand, in the absence of such price incentives, regulations limiting weight per axle may also be inefficient. There is evidence that at least some truckers would be willing to pay for the extra damage if allowed to carry heavier loads (Rufolo et al., 2000). Expanding capacity for railroads that require additional construction would be at best a long-term solution given the high cost and other constraints on adding rail capacity. However, the railroads have shown significant ability to improve productivity since deregulation, and they may find other methods to address the capacity constraint.


Transportation economics is a complex field that has received relatively little attention. However, the growing divergence between demand for travel and the resources available to finance transportation infrastructure is focusing attention on both the methods of finance and the efficiency incentives. Transportation economists argue that more effective pricing of transportation would improve operation of the existing system while also providing funding for improvements. However, direct pricing faces technical, political, and public acceptance issues. Ongoing experiments and demonstration projects are likely to lead to gradual increases in the use of pricing, but a major shift does not appear likely in the near future. Hence, further increases in congestion on roads and financial pressure on transit systems seem inevitable.

See also:


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