Modal choice and optimal congestion

We study the choice of transportation modes within a city where commuters have heterogeneous preferences for a car. As in standard models of externalities, the market outcome never maximizes aggregate welfare. We show that in the presence of multiple equilibria problems of coordination can worsen this result. We discuss two policy tools: taxation and traffic separation (e.g. exclusive lanes for public transportation). Setting the optimal policy is a necessary but not sufficient condition to maximize aggregate welfare. Even with a social planner maximizing aggregate welfare, a city may find itself stuck in a situation where public transportation remains inefficient and the level of congestion high.