Managing uncertain traffic and societal externalities in a road and rail network: Pricing versus Permits

Abstract

This paper studies the relative performance of congestion pricing versus tradable permits for a congested bi-modal transport system with traffic externalities, that affect passengers only, and societal externalities that go beyond the passengers. The point in this case is infection risks, as in the pandemic. We study this relative performance for the case where there are uncertainties on both traffic externalities and societal externalities. Earlier literature considered the relative performance of prices and permits for the case with only stochastic traffic externalities. The numerical results indicate that, given how infection risks are likely to affect social cost functions, pricing regulation can be expected to perform better than a tradable permit scheme when there are uncertainties on private infection cost, especially when the uncertainties on the marginal private infection cost increase. However, the government can enhance the performance of tradable permits by allowing the bankability of permits, or by actively engaging in buying or selling permits to optimize the price in response to the realization of stochastic parameters. The results provide theoretical support for policymakers to choose the optimal instruments to internalize the multiple external costs when uncertainties exist.