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Demand Slopes Downward

Posted By Russ Roberts On December 15, 2006 @ 2:02 pm In Prices | Comments Disabled

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 [1]:

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 [2] 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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[1] yesterday’s Washington Post: http://www.washingtonpost.com/wp-dyn/content/article/2006/12/13/AR2006121302341.html

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