Case Study

Case 1

In the early 1980s there was a controversy over the “Fares Fair” policy of cutting bus and tube fares in London. Some people thought low fares would increase passengers and bring in extra revenue for London Transport, which runs the bus and tube services. Others thought that low fares would lead to disastrous losses in running London Transport. Eventually the matter was referred to the courts. Suppose you had been a consultant brought in to analyse the relationship between tube fares and revenue from running the tube: how would you have analysed the problem?

To organize our thinking, or - as economists describe it - to build a model, we require a simplified picture of reality which picks out the most important elements of the problem. We begin with the simple equation.

In this stark form, equation (1) emphasizes, and thus organizes our thoughts around, two factors: the fare and the number of passengers. London Transport directly controls the fare, but can influence the number of passengers only through the fare that is set. (Cleaner stations and better services might also encourage passengers, but we neglect these effects for the moment.)

It might be argued that the number of passengers is determined by habit, convenience, and tradition, and is therefore completely unresponsive to changes in fares. This is not the view or model of traveller behaviour that an economist would initially adopt. It is possible to travel by car, bus, taxi, or tube, and decisions about a mode of transport are likely to be sensitive to the relative costs of the competing alternatives. Thus in equation (1) we must not view the number of passengers as fixed but develop a ‘theory’ or ‘model’ (we use these terms interchangeably) of what determines the number of passengers. We must model the demand for tube journeys.

We can study the theory of demand in detail. Applying a little common sense, we can probably work out the most important elements straight away. First, the fare itself matters. Other things equal, higher tube fares reduce the quantity of tube journeys demanded. Of course, what matters is the price of the tube relative to the price of other means of transport - cars, buses, and taxis. If their prices remain constant, lower tube fares will encourage tube passengers. Rises in the price of these other means of transport will also encourage tube passengers even though tube fares remain unaltered.

We now have a bare-bones model of the demand for tube journeys. We summarize this model in the formal statement:

This statement reads as follows. The quantity of tube journeys ‘depends on’, or ‘is a function of’, the tube fare, the taxi fare, petrol prices, bus fares, and some other things. The notation f (1) is just a shorthand for ‘depends on all the things listed inside the brackets’. In equation (2) we have named explicitly the most important determinants of the demand for tube journeys. The row of dots reminds us that we have omitted some possible determinants of the demand for tube journeys in an effort to simplify our analysis. For example, tube demand probably depends on the temperature. It gets very uncomfortable in the underground when it is very hot. Since the purpose of our model is to study changes in the number of tube passengers, it will probably be all right to neglect the weather provided weather conditions are broadly the same every year.

To answer our original question, it is not sufficient to know the factors on which the demand for tube journeys depends. We need to know how the number of passengers varies with each of the factors we have identified in our model. Other things equal, we assume that an increase in tube fares will reduce tube passengers and that an increase in the price of any of the competing modes of transport will increase tube passengers. To make real progress, we shall somehow have to quantify each of these separate effects. Then, given predictions for bus and taxi fares and the price of petrol, we would be able to use our model to predict the number of tube passengers who would want to travel at each possible tube fare that might be set by London Transport. Multiplying the fare per journey by the predicted corresponding number of journeys demanded at this fare, we could then predict London Transport revenue given any decision about the level of tube fares.

Writing down a model is a safe way of forcing ourselves to look for all the relevant effects, to worry about which effects must be taken into account and which are minor and can probably be ignored in answering the question we have set ourselves. Without writing down a model, we might have forgotten about the influence of bus fares on tube journeys, an omission that might have led to serious errors in trying to understand and forecast revenue raised from tube fares.

You have read the text. Check your understanding.

1) What controversy was there in 1980 over the ‘Fares Fair’ policy of cutting bus and tube fares in London?

2) How would economists organize the solution of fares problem?

3) How can the equation one organize our thoughts?

4) What organization directly controls the fares?

5) How can London Transport influence the number of passengers?

6) Is the number of passengers responsive to the changes in fares?

7) What theory or model should an economist develop to solve the problem of the number of passengers?

8) What is the relationship between fares and demand for tube journeys?

9) What is the dependence of the quantity of tube passengers on the fares of other means of transport?

10)For what purpose can we use the model given in the text?

11)How could we predict London Transport revenue?

12)What is the importance of building the model?

Case 2

Leipzig East Germany's second largest city, has attracted attention from office developers as it changes from a planned to a market system. The city has a shortage of office space. Most of its existing space is obsolete compared with Western standards. Also, if Leipzig is to achieve the status of other German cities, it needs to develop another 2 or 3 million sq.ft of office space. Developers are receiving a number of incentives, including grants, favourable tax treatment, EC regional grants and subsidised lending rates. Another attractive feature for developers is the state of rents. Because of the shortages rents have risen sharply and Leipzig is seen as a good investment opportunity by many property speculators.

However, there have been problems as the city copes with the transition.

§ Pollution from open cast mining in the countryside has disfigured much of Leipzig's building stock.

§ Inadequate building stock has resulted in housing shortages discouraging skilled workers from moving to the city. Hotel shortages have also restricted the number of visitors to Leipzig.

§ Poor transport infrastructure.

§ Many of the young and relatively well educated members of the population have migrated from the city. This has contributed to a population decline from 713,000 to 511,000 over a 50 year period.

§ Land ownership disputes have resulted in delays and frustration as land and property is transferred from the state to the private sector.

§ There has been a flood of goods from West Germany into the city.

You have read the text. Answer the questions.

(a) How far are the problems facing Leipzig a result of it being formerly part of a planned economy?

(b) How might cities such as Leipzig overcome the problems of changing from a planned to a mixed economy?

Case 3

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