Marginal cost pricing and subsidy of transit in small urban areas

This study analyzes economies of scale and density as a rationale for subsidizing transit agencies in small urban areas. A long-run cost model is estimated using data from 2006 to 2009 for 168 transit agencies that directly operated fixed-route bus service in small urban areas. Using vehicle revenue miles as transit output, results show that small urban transit agencies experience economies of scale and density. A full cost model is estimated that includes the addition of external costs and benefits. External benefits result from reduced waiting times following an increase in service frequency. Results are then used to estimate the optimal fare, which is equal to marginal social cost of service. The needed subsidy is calculated as the difference between the revenue generated by the optimal fare and that needed to maintain efficient levels of production. The rationale for subsidies is an important issue as many agencies have experienced recent reductions in operational funding. A survey was conducted that found that close to half of transit agencies in small urban areas have either reduced service or increased fares over the last two years, and the main reason for these actions has been a decrease in operational funding.