The Case for Subsidisation of Urban Public Transport and the Mohring Effect

Abstract

In this journal, van Reeven (2008) develops a model aimed at showing that scale economies on users' time costs would not provide a justification for public transport subsidies. He claims that a profit-maximising operator allowed to take the demand effects of its pricing into account would offer a frequency f(pi) at least as high as a welfare-maximising one f*, and with no welfare losses. We show that his result depends crucially on a strong assumption of demand. Introducing a slight modification to make it more realistic, we show: (i) f* > f(pi), (ii) welfare losses emerge under profit-maximisation, (iii) subsidies are required for first-best operation. Thus, the Mohring effect is a valid argument for subsidisation.