Driven by problems of traffic congestion, U.S. policy toward urban highways has lurched over several decades from highway building to high-occupancy-vehicle lanes to travel demand management. Yet congestion has worsened, and there is scant evidence that these policies have had any appreciable effect on it. As financial straits tighten, policy analysts are looking for new solutions. 

Meanwhile, economists have been polishing up a long-standing proposal known as congestion pricing. Under this policy, drivers would have to pay a very high fee for driving on the most popular roads during peak hours. We already expect to pay top price for long-distance phone calls during business hours, and many of us wait for discounts at night. But can the same concept work for highways?

Sustainability of transportation depends on both behavior and technology. Behavior determines how much of various activities are undertaken; technology determines whether they are harmful to the environment. Policies can influence both: they provide behavior incentives, and they affect technological choices and guide technological change.

When a firm or public authority prices output at marginal cost, its profits are related to the degree of local economies of scale in its cost function. As is well known, this result extends to the case where some congestion-prone inputs are supplied by users. I show that contrary to common belief, the result holds even when scale economies are affected by a rising factor supply curve. In that case, constant returns to scale in production produces diseconomies of scale in the cost function, making marginal-cost pricing profitable. Examples are provided for a monopsonist both with and without price discrimination. In the latter case, second-best pricing is also considered: profits then are not governed in the usual way either by returns to scale in production or by scale economies in the cost function, but some useful bounds are provided.