K.U.Leuven, Faculty of Economics and Applied Economics : Department of Economics
CES - Discussion Paper Series (DPS) 06.10 pages:1-30
In this paper we study the problem of a city with access to two subcentres selling a differentiated product. The first subcentre has low free flow transport costs but is easily congested (near city centre, access by road). The second one has higher free flow transport costs but is less prone to congestion (ample public transport capacity, parking etc.). Both subcentres need to attract customers and employees by offering prices and wages that are sufficiently attractive to cover their fixed costs. In the absence of any government regulation, there will be an asymmetric duopoly game that can be solved for a Nash equilibrium in prices and wages offered by the two subcentres. This solution is typically characterised by excessive congestion for the nearby subcentre. We study the welfare effects of a number of stylised policies by setting up a general model and illustrating the model using competition between airports as an example.
The first stylised policy is to extend the congested road to subcentre 1. This policy will not necessarily lead to less congestion as more customers will be attracted by the lower transport costs. The second policy option is to add congestion pricing (or parking pricing (etc.) for the congested subcentre. This will decrease its profit margin and attract more customers. The third policy is acceptable for politicians: providing a direct subsidy to the remote subcentre, reducing its marginal costs. This policy will again ease the congestion problem for the nearby subcentre but will do this in a very costly way.