bikes, because we care

The City of Madison installed a system of city bikes the other day. You know, the bikes you can rent, point-to-point, for a couple bucks. I checked them out—it’s a pretty nice set-up: basket, internal gears, bell, and a little Trek logo on a shiny red paint job. I haven’t ridden one but they look pretty snazzy. I heard from someone that they’re a thousand bucks apiece!

These types of rental systems are growing in popularity around the country. I spent a weekend rolling around on some in DC. And our Bike Czar in Boston (yes, we had a Bike Czar) talked them up all the time. When I took the picture above, there was only one bike left. But I don’t think it’s profitability of this system that drives the adoption. I would be surprised if these systems are profitable at all. As I mentioned in my analysis of Deposit Refund Systems, if systems like this were profitable they would have emerged privately in an attempt to capture those profits, without the need for public support. So what’s the market-driven, conservative justification for a city-bike system designed to run at a loss, necessitating funding by our tax dollars? Keep reading.

When designing my curriculum on healthcare economics, I came across an interesting market failure: the caring externality. Let me explain while applying it to our bright red city-bikes.

I directly benefit from the existence of this infrastructure. (Yes, I’ll dare to call it an investment in infrastructure.) I benefit because I get to tell people that we have this system. They say “that’s cool” and “maybe I’ll rent one someday!” I care about the very existence of the system—even though I would never use it. (I have four bikes that cost more than my car!) These benefits are called externalities: I am neither the producer nor consumer of this product—yet I benefit. When a consumer benefits, they pay for it in the form of the rental price transferred to the producer. And I sit along the side drinking a coffee in the shade and reap benefits without transfer.

In a perfect market, the amount paid by the consumers (private marginal benefit) is equal the amount it takes to run the businesses that provides the product (private marginal costs). So in this perfect market, the private marginal benefit is equal to the social marginal benefit, meaning, that the sum of all of the benefits consumers receive (consumer surplus) plus benefits producers receive (producer surplus) is equal to the benefits added to society. There’s no third party that receives unpaid benefits or costs. This is where the breakdown is in our example. Since I benefit—because I care—and am not a consumer, society benefits more than the consumer market is willing to pay for (SMB>PMB, the true demand curve actually lies further outward.) The market left alone will embody this inefficiency and societal gains can be achieved by government intervention through subsidies.

So there’s our theoretical justification. What happens in practice is more political. Does the increased societal gains outweigh the inevitable overhead and transfer costs? Are the incentives correctly aligned to maintain the system and keep costs down as a for-profit company would? The intricacies of the systems, the rules of the game, will decide this. As we often see, the rules can convolute such systems to the point where we begin wonder if it’s worth it at a time when its removal is out of the question (unemployment insurance, agricultural subsidies, high trade barriers, etc.)