Summary of the Caveat for research report RR552 – Metropolitan rail: external benefits and optimal
funding
The caveat outlined the approach the research author’s adopted. The researchers proposed a two-step
process for determining the level of public funding for metropolitan rail, namely:
1. ensuring prices are ”economically” efficient with fare setting based on the marginal cost of additional
usage
2. that positive externalities arising from rail usage justify additional subsidisation to reduce fares below
marginal cost
Based on the above two-step approach the research provides estimates of both marginal costs of metropolitan
rail services and the positive externalities of rail usage, based on cost information and transport modelling
from two regions.
The caveat’s author (the author) details two concerns or reservations with the approach adopted by the
researchers:
1. In terms of determining economically efficient prices the researchers suggest that the marginal cost
approach should be adopted rather than an average cost approach. There is a long history (from 1890) of
the controversy about using marginal cost or average cost (see for example the article by Fruschmann and
Hogendorn, Journal of Economic Perspectives, Winter 2015, p193-206). To support this the author
quoted Duffy (article: “The marginal cost controversy in intellectual property”, University of Chicago Law
Review, 2004, 71, 37-56) which summarised the dominant approach and concluded:
“In short, modern public utility theorists generally do not recommend using the pervasive public
subsidies to chase the Holy grail of global marginal cost pricing.”
Based on this, the author considered that, in deciding the efficient fare, it would have been crucial to
determine the rail fare elasticity of demand. The report authors seem to suggest that if average pricing is
adopted then a substantial number of rail users would switch modes. However, no evidence is provided to
substantiate whether this proposition is correct.
2. In terms of determining the cost of the spil overs/externality effects, the author noted that the research
should have addressed the cross elasticity of demand. If the cross elasticity of demand is low then mode
switching is likely to be low and this raises the issue of whether subsidies are necessary. This is an
important matter that should have been discussed in the research. The author also noted reservations
with the way the positive externalities were calculated, as it is unrealistic to assume that the road network
and land use would have developed in the current form if there was no rail network.