Demand Slopes Downward

by Russ Roberts on December 15, 2006

in Prices

Even in Washington, D.C., demands slopes downward. The city has proposed raising fares on the city’s subway, the Metro, as a way to eliminate a multi-million dollar deficit. From yesterday’s Washington Post:

Rush-hour Metrorail riders face a $2.10 fare increase, and some
off-peak passengers could get discounts under a proposal designed to
raise money, change rider habits and ease crowding.

The possible
changes are part of a far-reaching plan that Metro budget officials
present to the agency’s board today that could drastically alter how
much riders pay and how they pay it. The plan is aimed at closing a
$116 million budget shortfall, but it also attempts to improve service
by encouraging the use of electronic SmarTrip cards and changing the
times that people use the subway.

Somehow, when there’s a budget shortfall, people always assume that the solution is to raise prices. Increases in prices can lead to higher revenue. But revenue is the product of price and quantity and when you increase price, you inevitably get lower quantity—demand slopes downward. The question is, how much lower? If the decrease in quantity is large enough, it can offset the increase in price and actually lead to lower revenue. Sometimes, the way to raise more money is to lower price and attract enough customers to offset the drop in price.

Today, the Post reports that demand slopes downward and that demand may be sufficiently responsive to price to cause real problems for the Metro system’s plan:

Scores of Metro riders, reacting angrily to proposed fare increases,
say the hikes are so dramatic that taking the subway may no longer make
sense, raising the possibility that large numbers will ditch mass
transit altogether.

"It’s ridiculous," Mike Green, 42, who takes
the Red Line during rush hour between Shady Grove and Farragut North,
said in an interview. "Surcharging people to ride during rush hour is
like saying goodbye to the commuter," he wrote in an earlier e-mail. "I
will drive."

Talk is cheap. We’ll see many riders will actually start driving. But it is always good to remember that when you change a price, you can’t hold everything else constant. I wonder if the Metro even considered the likelihood of a reduction in ridership in response to a fare increase.

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{ 16 comments }

Paul McMahon December 15, 2006 at 2:18 pm

Dr. Roberts,

One factor that might mitigate the affect of an increase is that many federal employees have their fares paid for by the government. This is the result of a program that is intended to reduce car rides and thus decrease air pollution.

One might take this move by Metro, then, as an attempt to get a back-door subsidy.

CC December 15, 2006 at 2:28 pm

Another factor that needs to be considered here (and in other cases as well) is the current supply capacity/quantity of the service. If demand is already much less that 100% (say 50%) of available supply/capacity, that should already tell them something about (current) pricing (yeah…I know…these aren't business people). They could (potentially) decrease rates and see an aggregate increase in revenue.

Often times I find that current demand/supply/capacity/utilization is never considered.

For example Democrats in congress now desire to enable more people to go to college by lowering student loan rates and providing more grants to students. But if colleges are already generally full (and given the costs of college, one could assume this to be the case)…they will simply end up with more demand chasing the same amount of supply…thus…wait for it…causing colleges to actually increase the cost of getting in (directly or indirectly) making it harder to get in! Oops.

Lenny December 15, 2006 at 2:51 pm

As you say, talk is cheap. If the demand is predicted based on how people respond to reporters then I wouldn't put much value on that prediction.

It sounds as if demand is pretty high – at least during rush hour so differential pricing makes sense.

What's the chance that they're smarter than they appear; i.e. if they can get the approval for a high base rate then they can offer all sorts of discounts as a way of adjusting prices in response to demand. Otherwise they're stuck with a price that can't be adjusted without the politicians approval.

Adam Malone December 15, 2006 at 3:27 pm

This makes me wonder if they have considered the possibility that people are already offsetting their ride times as much as possible. I mean we have rush hour traffic for a reason, most jobs start within a culturally acceptable time frame and end at another culturally accepted time.

The subway system already has fare differentiations. Rush hour vs. offpeak prices are sometimes 2:1.

It is likely that No matter the change in price that occurs offsetting rush hour more riders will be nearly impossible.

When I was in DC in the Spring I was there to sight see, so I could ride when I felt it convenient. As a result I rode in the off peak hours because it was cheaper. But I did notice that peak hours were defined so broadly that it was unlikely that many workers could/would use it as an excuse to ride later.

Matt C. December 15, 2006 at 3:38 pm

There other factors that also must be taken into consideration when talking about the Metro, especially around DC. For example I work near Union station, but I live 10 mins south of Baltimore. My wife works in Arlington. We both take the MARC train into work.

First it would be interesting to see if that will impact the ridership of MARC/VRE commuter rails and decrease the ridership on the outer spokes of the Metro.

Secondly, the current gas prices still make it much better to take the transit system. It also takes away the hassle of sitting in traffic, this is the main reason my wife rides both the MARC and takes the METRO out to Arlington.

I have always believed that both commuter rails and the Metro system should be privatized. Just as Dr. Roberts suggest it would allow companies to compete for ridership. For example, rather than traditional rail companies could operate maglev or monorail systems. If the green line is owned by one company and the Red line a different company, if one were to offer better prices, better service, they would do much better. Those same companies might offer buses to other parts of the city where they don't run lines. It would be difficult to set up a system similar to the smart trip where it debits the dollar amount and is then sent to clearinghouse to the appropriate vendor.

My two cents.

Christopher December 15, 2006 at 6:05 pm

I'm from the DC area, and have been reading about this a lot the last couple days.

As you said, talk is cheap. I bet that Metro fares are fairly inelastic: not many people will jump ship.

Also, Metro had a choice to make: up fares, to pay for the trains they run, or leave fares and cut service. The cries now, however loud they may be, are nothing compared to when Metro experimented with less trains back a few months ago.

Bill Nelson December 15, 2006 at 6:49 pm

Metro's revenues are negative, as they require subsidies to run the trains. Therefore, if they want to maximize revenue, they should increase the fare to $10,000 to eliminate all ridership, which would thereby raise their revenue to zero.

Jasper December 16, 2006 at 8:31 am

******* "I wonder if the Metro even considered the likelihood of a reduction in ridership in response to a fare increase." *******

Surely a large organization like the public transit authority in D.C. would have a few economists or analysts in its employ. No?

Lowcountryjoe December 16, 2006 at 11:00 am

Do mass transportation riders consider the alternatives of not riding as they complain loudly. Car payment, insurance premiums, refueling, and maintainance cost…let's see them do better. In fact, I'd say if mass tranportation riders aren't already shelling out at least one quarter of what most car owners do in car upkeep costs — in order to be a passanger — then they have no business expecting sympathy to their complaints.

false_cause December 16, 2006 at 3:07 pm

To Lowcountryjoe,

I believe a great number of the people who use the Metro to commute to work do already own cars. With that in mind… from my station, a $2.10 increase in fares would make a rush-hour round-trip ride to Union Station cost $9.20. We're getting mighty close to covering everything including feeding a meter.

Lowcountryjoe December 16, 2006 at 11:02 pm

Good! I really think that $10 a day for 20-22 working days seems about 'fare'…even if the amount is much higher than what I thought it might be.

bartman December 16, 2006 at 11:37 pm

Uh, Bill, revenues can't be negative. Of course, operating costs may be greater than revenue, thus causing profit (or for a non-profit, operating surplus) to be negative.

Anyway, the cost/benefit calculations for something like the Metro go beyond the revenues. Reducing traffic congestion is worth a great deal to the region.

I'm willing to bet that someone, somewhere in the Metro has at least tried to estimate the price elasticity of demand.

Adam Malone December 18, 2006 at 12:24 am

Christopher-

You forgot a third choice…reduce the price of fares leading to an increase in revenue.

On the surface it is counter-intuitive but it has been proven over, and over.

For example Bush has systematically lowered taxes (yes many were focused on tax breaks for the wealthy) while tax revenues have increased steadily.

Lower prices do not necessarily equal lower revenue.

Google "Laffer Curve" and see what you come up with.

True_Liberal December 18, 2006 at 7:56 am

Good golly, Adam, you mean the Laffer Curve applies to the Metro? I thought the all-wise Left debunked that 20+ years ago!

Half Sigma December 18, 2006 at 4:42 pm

Metro fares are surely very inelastic.

But when I lived there, I never rode it to work because of the exurbanization of the DC area. The Metro only works if you work in DC, but all the jobs were in stupid places like Tyson's Corner and the place with the big I-395 highway interchange.

JohnDewey December 19, 2006 at 12:13 pm

"But when I lived there, I never rode it to work because of the exurbanization of the DC area."

That's why trains will not work in any modern city – not in DC or Dallas or Denver or Phoenix or anywhere else. Trains are a 19th century, pre-automobile "solution" to a problem that no longer exists. I'm amazed that suburban voters are so naive in believing these hub and spoke networks, designed to save decaying center cities, will help their commute from suburban home to suburban job.

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