Wednesday, June 10, 2009

An economic explanation for subsidizing FrontRunner

Published in Standard-Examiner, Ogden, UT, June 10, 2009


Professor Michael Ransom, in his opinion piece "The economics of FrontRunner" in the Standard-Examiner on May 9, came to the conclusion that "riders are subsidized to the tune of $1000 to $1500 per month, depending upon what we think ridership actually is." This estimate of the subsidy is based upon the difference between the monthly pass price of $162 and the average monthly roundtrip total cost per rider (consisting of capital cost and operational cost) of $1144 to $1850. Professor Ransom questions the benefits of FrontRunner to Utahns given the magnitude of the subsidy and hence does not consider it as sound economic investment. There are others who concur with Professor Ransom's point of view.

My purpose here is not to debate the cost estimates of Professor Ransom but to point out that there are economic justifications for subsidizing FrontRunner. Mass transit system is like a natural monopoly, in the same sense as a local public utility. In order to make the case for subsidy, the notion of natural monopoly and its cost characteristics need to be clarified. A natural monopoly can supply the product or service to the entire market at a lower cost, as opposed to the cost in a market structure consisting of many competing firms.

Natural monopoly arises when there are economies of scale. The scale economies in a mass transit system result primarily due to very high capital cost of building a heavy rail system (a cost which is invariant to the level of ridership) and very low marginal cost (additional cost per additional rider). In the case of FrontRunner, capital cost was very large but additional cost per extra rider is relatively low.

Therefore, with scale economies cost per rider (average cost) and marginal cost decline as the number of riders on FrontRunner increase. However, marginal cost falls more than the decline in average cost as ridership increases.

The question is, do we have to subsidize ridership on FrontRunner? If FrontRunner charges a price based upon average cost as implied by Professor Ransom, there will not by any need for subsidy; however at that price it would be operating the service at an economically inefficient level.

The most well understood economic principle is that a company should produce that level of output or service where the marginal benefit to the consumer is the same as marginal cost. In the FrontRunner case economic efficiency requires a level of ridership where the price (marginal benefit) is equal to marginal cost, and since marginal cost is lower than the average cost per rider, the subsidy per rider is equal to the difference between average and marginal costs.

The subsidy level would in general increase if ridership demand falls due, for example, to the decrease in gasoline prices, as is currently the case. The fact remains that as long as marginal cost is below the average cost per rider, subsidy is economically justified.

External benefits provided by FrontRunner riders is another reason for a subsidy to FrontRunner. Drivers on our highway system not only incur private costs of driving their automobiles, e.g., fuel cost, finance charges, insurance costs, maintenance and repair costs, but they also cause external costs like congestion cost (other drivers' time lost in delays during peak hours) and pollution cost associated with air, water and noise pollution. For example, passenger vehicles are estimated to contribute almost two-thirds of the total CO2 emissions of the transportation sector. Automobile travel is underpriced because the average highway commuter does not pay for these external costs.

The case for FrontRunner is further strengthened if one adds other costs, such as costs associated with violence due to road rage, damages to property and loss of life due to highway accidents during peak and off-peak times. In Utah 287 people were killed in motor vehicle crashes in 2006, a 1.8 percent increase from 2005.

Riders on FrontRunner provide benefits to motor vehicle drivers and others in the form of reduction in congestion, pollution and traffic accident costs.
Therefore, economic efficiency requires that motor vehicle commuters and others pay a higher tax on gasoline. The tax revenue can be used to subsidize FrontRunner.

FrontRunner is a significant asset both to the counties involved and to the state of Utah because it complements the general transportation network. In order to provide transportation service at minimum social cost, it should be supported and expanded to meet current as well as future growth in demand.

Mathur is former chair of the economics department and professor emeritus of economics at Cleveland State University in Cleveland, Ohio. He is also an adjunct professor of economics at Weber State University, Ogden, UT. His articles can also read at He resides in Ogden.

No comments: