Entry deterrence and quality provision in the local bus market

In a deregulated bus market, incumbent operators often seek to deter entry by setting frequency levels to avoid leaving profitable gaps. The consequences of this action have been analysed using a simulation model of a hypothetical incumbent bus operator vulnerable to entry. The model features two dimensions of quality: a 'horizontal' frequency dimension and a 'vertical' quality dimension. It is examined whether, from a social point of view, such entry deterrence strategies lead to oversupply in the horizontal frequency dimension; what the consequences of this are for the supply of vertical aspects of quality; and what the impact of regulation and quality/output related subsidies would be. The results suggest that an incumbent operator will indeed oversupply in the frequency dimension to deter entry. It undersupplies in the quality dimension, though, but supplies more quality than would have been done in the absence of an entry threat. Quality regulation and quality subsidies can lead to modest welfare gains, but nowhere near those that can be achieved using price regulation or output subsidies. If paying subsidies results in further oversupply of bus miles, the welfare effects of the subsidies may be limited or even negative.