The UK Rail Industry — Demand and Supply, Cross Elasticity and Infrastructure Decisions

Answers

(a) Cause of the changes in fares and passenger numbers [2] — state

Both rail fares and passenger numbers rose, which is consistent with a rise in demand outweighing any change in supply. A growing UK population raises the demand for rail services (the demand curve shifts right). With supply roughly constant — or contracting if privatised operators cut services — the increase in demand exceeds the change in supply, creating upward pressure on price. Equilibrium fares rise and equilibrium quantity (passenger numbers) rises with them.

(b) Subsidise rail or bus to reduce car usage? [4] — comment

A subsidy to public-transport producers lowers their cost of production, raising supply and putting downward pressure on fares; cheaper rail or bus then induces car owners to switch to the substitute.

Which to subsidise turns on the cross elasticity of demand of car with respect to each. The XED of car w.r.t rail (0.196) exceeds that w.r.t bus (0.116): car demand is more responsive to a change in rail fares than to bus fares. So a given fall in rail fares draws more drivers off the road than the same fall in bus fares. To reduce car usage most effectively, the government should subsidise rail rather than bus.

Comment: the two are not mutually exclusive. Both XEDs are positive (both are substitutes for the car), so subsidising bus would still divert some drivers — especially where park-and-ride schemes exist. The government might also act on the other side by raising the cost of car ownership directly, rather than relying on subsidies to substitutes alone.

(c)(i) Opportunity cost of building HS2 [2] — explain

Opportunity cost is the value of the next best alternative forgone. Committing public funds to HS2 means those funds cannot be spent on the next best use — for example investing in higher education, which might have made the UK a more attractive destination for foreign direct investment. The forgone benefit of that alternative is the opportunity cost.

(c)(ii) Factors in the decision to build HS2 [8] — discuss

The government must weigh the benefits, the costs, and the constraints on the decision.

Benefits. Building HS2 is government investment in infrastructure, raising AD; the associated development (capital spending by construction firms) adds further to AD. With spare capacity, the multiplier magnifies the rise in national income, and employment rises across construction, civil engineering and rail — reducing demand-deficient unemployment. Stronger growth and lower unemployment raise income-tax revenue and cut unemployment benefits, easing government debt. Over the long run, the new capital raises productivity — workers and goods move faster — lifting productive capacity (potential growth) and relieving demand-pull inflation if the economy is near full capacity.

Costs. Construction costs are substantial — compensation to disrupted residents, upgrading of linked stations, and large operating costs. Residents along the route bear years of disruption and noise pollution that lowers their quality of life and depresses local house prices. (This is a private cost the government has chosen to compensate, not a pure external cost.)

Constraints and judgement. The cost-benefit figures are estimates by the government and bodies such as the IEA, limited by the information available and potentially biased toward the estimator’s position — so costs may be under- and benefits over-stated. Funding is a further constraint: a high and rising government debt raises the difficulty and cost of borrowing to finance the project. The decision should therefore rest on a cost-benefit comparison that accounts for future as well as present streams: if expected net benefit is positive and the cost lies within the government’s fiscal constraints — so that future revenue can repay the investment and any loans — building HS2 is justified; otherwise it is not.