This chapter examines the progress made during the past few decades in understanding transportation costs. Specifically, the chapter focuses on the costs incurred by carriers in providing railroad, motor carrier, airline, or other transportation services. Many other types of costs are not addressed here, such as congestion costs, pollution costs and other externalities, and other costs to users of transport services, such as the value of time in travel. Progress in understanding has come on three fronts. First, there have been significant advances in the theoretical understanding of costs. For example, early cost studies did not recognize the proper role of factor prices in a cost function. Researchers such as McFadden and Nerlove showed the importance in empirical work of specifying cost functions that are consistent with production theory, including not only a proper treatment of factor prices, but also variables that might contribute to a change in technology over time. Although these principles are now part of the material covered in standard graduate and even undergraduate courses in microeconomics, they helped define a renaissance in empirical studies of costs and production functions.

Second, improvements in empirical techniques have made it possible to learn more than ever about the underlying structure of technology in an industry. Early cost studies were often based on simple functional forms that embodied very strong assumptions about the nature of technology. They also were highly aggregated, effectively treating transportation firms as single product enterprises, and they often paid little attention to the quality of services provided. Empirical work in the past two decades has been advanced by the introduction of more flexible functional forms that contain as special cases many of the more specialized functional forms used by early investigators. Researchers have also improved techniques for studying the costs of multiproduct firms, allowing at least some degree of disaggregation of products.

Finally, as regulatory reform has been implemented, researchers have asked new kinds of questions about technology. For example, in the past regulators often studied costs to determine whether a firm’s revenues would cover its costs or to measure the extent to which total costs could be divided into fixed and variable costs. Over time researchers have learned the importance of incorporating features of the transportation network into cost studies, for example, by distinguishing economies of size from economies of density. As regulatory reform became a real possibility, researchers began to ask whether is was likely to lead to an industry structure compatible with competition.

To understand the evolution of transportation cost studies, it is useful to begin with a brief discussion of the kinds of cost studies that the Interstate Commerce Commission (ICC) commonly used before regulatory reform. Because issues of rail rate making were important even before the turn of the century, much of the early effort to measure transport costs focused on the railroad industry. Several academic researchers succeeded in pointing out the limitations of regulatory costing procedures and inspired a generation of improved studies. From that beginning point, I follow the flow of literature through a series of improvements in the use of theory and empirical techniques.

After discussing several studies that have made important methodological contributions to the literature, I summarize findings from several of them about the major characteristics of selected transport modes, including economies of scale, density, size, and scope. At the outset, however, I note that this chapter is not intended to provide a comprehensive survey of transportation cost studies, an effort well beyond the scope of this paper and also one that has attempted elsewhere, including the recent excellent survey by Oum and Waters.