Regulating a public transit monopoly under asymmetric cost information

Abstract

The regulation of a monopolistic public transit operator whose marginal cost is unknown to the regulator is studied in this paper. We contribute to the transit regulation literature by presenting an incentive-compatible (IC) regulatory policy with consideration of the decision interactions between the regulator and transit operator under asymmetric information. The regulator only has some subjective prior probability distribution for the unknown marginal cost before designing regulatory policies (i.e., probability of permitting operations, maximum fare, maximum headway, and subsidy amount) to maximize the expected social welfare over the unknown cost. The operator with privately held cost information optimizes its fare and headway decisions subject to regulatory policies. The proposed IC policy is derived analytically, which gives the operator no incentive to misrepresent its cost. We compare regulations under symmetric information versusasymmetric information, and measure the deadweight loss due to the information asymmetry. The proposed IC policy is also compared with a benchmark policy, which is based on the cost expected by the regulator, to demonstrate its superiority. We find: (1) solutions under asymmetric information can be reproduced by solving the regulation problem under symmetric information with an enlarged marginal cost; (2) a regulator adopting the benchmark policy may set fare and headway limits above the levels selected by a profit-maximizing monopolistic operator. This study improves the state of the artin public transit regulation by presenting an effective tool for designing IC regulatory policies.