Social Cost Pricing when Public Transport is an Option Value

Abstract

A well-known principle of welfare economics states that an efficient allocation of resources can be achieved in a competitive economy when market prices are in line with social marginal costs. When applied to the transport sector, this implies that the price of the various transport modes should be made equal to the sum of marginal production and external costs, like congestion, accidents, pollution, and road maintenance. It is sometimes argued the internalization of external costs would bring about a change in demand patterns with a shift towards public transport and cleaner modes. But public transport is already favoured by discriminatory fiscal treatment. Whereas public services are normally (heavily) subsidized, private transport is taxed in several ways and, in some countries, quite substantially so. The application of the 'optimal pricing' principle, therefore, critically depends on how the subsidization of public services is interpreted. This paper addresses the issue of optimal pricing of urban transport, using different hypotheses concerning the treatment of public services. After reviewing some traditional arguments in favour of public transport subsidization, a new approach, based on uncertainty and option values, is discussed. The implications of this approach are investigated by means of an applied model, where optimal prices for urban transport services in the city of Bologna are computed under alternative assumptions.