Northern Pacific Railroad (NP) has a commuter operation that services passengers along a route between Vancouver and Whistler. Problems of cost allocation were highlighted in a news story about NP’s application to the Public Utilities Commission (PUC) for a rate increase. The PUC staff claimed that the “avoidable annual cost” of running the operation was $700,000, in contrast to NP officials’ claim of a loss of $9 million. PUC’S estimate was based on what NP would be able to save if it shut down the commuter operations.

The NP loss estimate was based on a “full allocation of costs” method, which allocates a share of common maintenance and overhead costs to the passenger service.

If the PUC accepted its own estimate, a 25 percent fare increase would have been justified, whereas NP sought a 96 percent fare increase.

The PUC stressed that commuter costs represent less than 1 percent of the systemwide costs of NP and that 57 percent of the commuter costs are derived from some type of allocation method—sharing the costs of other operations.

NP’s representative stated that “avoidable cost” is not an appropriate way to allocate costs for calculating rates. He said that “it is not fair to include just socalled above-the-rail costs” because there are other real costs associated with commuter service. Examples are maintaining smoother connections and making more frequent track inspections.

1. As Public Utilities Commissioner, what approach toward cost allocation would you favour for making decisions regarding fares? Explain.

2. How would fluctuations in freight traffic affect commuter costs under the NP method?