Incentive subsidy scheme design with elastic transport demand

Huge public transport subsidies caused by deficits have become a heavy financial burden on some local governments due to the decline of bus passenger numbers. It is essential to apply the performance‐based contract to bus services considering maximization of social welfare. This paper constructs an incentive subsidy contract considering the decision‐making powers of the service level and calculating the proper frequency elasticity aiming at two problems of performance‐based contracts. Meanwhile, we consider a role of bus operators ignored by most researchers. Under the scheme, the decision‐making power of the service level is discussed based on five assumptions, and meanwhile, bus operators are motivated to reduce cost and improve service level in the scheme. The case of the bus service of Arao city indicates that the optimal frequency equals to zero when bus operators decide frequency. If bus operators determine efforts, the optimal effort also equals to zero with the goal of maximizing the profit. Also, bus operators can play their roles in lessening cost and improving service level to help bus operators and the local government achieve a win‐win situation, which maximizes the social benefit in this subsidy scheme when all factors are decided by the government. Copyright © 2013 John Wiley & Sons, Ltd.