Download Should governments subsidise rail fares?

Should governments
subsidise rail fares?
Steve Earley
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The background
•
Economists maintain that government involvement in specific aspects
of economic provision is justified whenever market failure occurs.
•
Where the price mechanism fails to produce a desirable outcome from
society’s point of view, state intervention is a way to enhance economic
welfare.
•
Overcrowding on UK roads causes congestion – a classic example of
market failure.
•
Fare subsidies paid by government to rail operators is a potential
solution to decreasing road congestion and economic waste.
The problem of
road congestion 1
• Road capacity can cope with traffic flows up to quantity OX.
• Up to this point, an extra road user does not adversely affect the speed
of other road users. There are no third party problems of time wasting.
• With levels of demand up to D1, there is no
variation between marginal private cost and
marginal social cost - meaning there is no
external cost and the free market delivers
allocative efficiency.
The problem of
road congestion 2
• Once the volume of traffic exceeds OX there will be a ‘spill-over’ cost on
other road users as time will be lost due to increased congestion.
• If demand was shown by D2, the free market would deliver a traffic flow
of OQ journeys, where D = S (MPC).
• As this exceeds society’s optimal level of OQ*, where D = MSC,
inefficient use of road space results.
• Overconsumption of road space
occurs with a deadweight loss to
society shown by the shaded
triangle. The CBI estimates that
this time wasting costs the UK
economy over £20 billion per
year.
The subsidy solution
• The provision of subsidies to providers of rail services is one way of
reducing demand for road use.
• Government provision of subsidies will shift the supply curve from S to
Ssubsidies.
• A new market equilibrium will result at OPs
rather than at OP, leading to an increased
use of rail services from OQ to OQs.
• With some of these extra rail
passengers having switched from
using cars, the demand curve for
road use will shift to the left and help
to diminish the market failure of
overconsumption of road space.
Some issues 1
• Keynesians refute the classical assertion that the economy is selfregulating, believing that it will stay in recession unless the government
or central bank take action to boost aggregate demand.
• Is price of prime importance when choosing to travel by train?
• If the price elasticity of demand for rail travel is inelastic, only a limited
amount of extra passengers may be attracted by lower prices.
• If the railway network is not in exactly the right places to meet
the needs of consumers, then it may be better to use the money
to improve the provision of rail services.
Some issues 2
• Non-price factors may be more important in determining the extent of
car travel, such as time saving and convenience.
• Where the cross elasticity of demand for road journeys with respect to
a change in price of rail fares is inelastic, there would be limited impact
in reducing the demand for road use.
• Even if price and cross elasticities were conducive to encouraging
greater rail travel, the rail network might not be able to cope with the
extra demand.
• In this situation of inelastic supply, attracting more customers
but being unable to accommodate them would be counterproductive.
Some issues 3
• Over time subsidised rail fares may lose their attraction as incomes
grow.
• Where rail travel is seen as an inferior good, with a negative income
elasticity of demand, subsidised fares may not work in periods of rising
prosperity.
• Travellers attracted by lower subsidised prices may be offset by others
switching to road travel as a result of rising incomes.
• The money spent on subsidies would then be better used in another
way.
Conclusions
• The use of public money to fund fare reductions for rail travel could well
have little real impact on rail customer numbers in either the short or
long run.
• Elasticity concepts of both demand and supply indicate that subsidies
which lower the price of rail travel may fail to achieve any meaningful
effect on our congested road network.
• Money could be better spent to improve the breadth of provision of rail
services and the overall quality of service offered.