WHAT IS 'Congestion Pricing'

Congestion pricing is a dynamic pricing strategy to regulate demand by increasing prices without increasing supply. Congestion pricing is common in the transportation and shipping industries, but is also used in services and utilities in which demand varies over time, including electricity and telecommunications.

BREAKING DOWN 'Congestion Pricing'

Congestion pricing is system of surcharging customers of services or products which are subject to temporary or cyclic increases in demand. Excess demand is regulated by applying higher prices during peak demand cycles.

While frequently applied to transportation resources, congestion pricing is not limited to transportation; it can be used with any service that faces varying levels of demand by time of day, such as electricity. Congestion pricing is supposed to encourage users who can be flexible in their usage times to shift their use away from peak periods to times when use is less expensive. One criticism of congestion pricing is that it acts like a regressive tax, harming low-income users more than other groups.

A variety of congestion pricing known as surge pricing has been implemented in recent years by companies such as Uber, which surcharges rideshare customers during peak hours.

Theoretical Background of Congestion Pricing 

The rationale behind congestion pricing is drawn from market economics and congestion pricing is considered a demand-side solution to regulating traffic.
The objective use of congestion pricing is to use an increased price to make the user conscious of the costs they impose when consuming a resource during peak demand. The theory posits that consumers will use and waste more of a resource which is free or negligible in price. By increasing the price of a resource, the users’ willingness to pay for that resource fuels a scarcity of that resource.

Nobel-laureate economist William Vickrey first proposed adding a distance- or time-based fare system to manage congestion on the New York City Subway in 1952. As a result, Vickrey is considered by some to be the father of congestion pricing.

Maurice Allais, also an Nobel Prize-winning economist, elaborated on congestion pricing theory to manage road traffic congestion, and was key in designing the first road pricing system, the Singapore Area Licensing Scheme, implemented in 1975.

While a majority of economists agree about economic viability of some form of road pricing to reduce traffic congestion, and congestion pricing has reduced traffic congestion in urban areas where it has been implemented, it is not seen by all as a equitable strategy because of economic burdens placed on communities neighboring areas of congested traffic and on retail and other economic activity located within these regions.

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