Qn.1 What is meant by demand?

There are two forms of demand; individual demand and market demand. According to Sexton (2012, p. 158) individual demand refers to the quantities of a commodity that the consumers are able and willing to buy at each possible price during a given period of time, other things held constant.On the other hand, market demand for a commodity is the sum of quantities demanded by individuals at each possible price. In general terms, it refers to the relationship between price and demand (Jain & Khanna, 2011, p. 53). Siddiqui (2006, pp. 35-36)identifiedfive constituents of demand. These he highlighted as; the desire for a good, money to satisfy the desire, willingness to spend the money, relationship of the price and quantity of the commodity demanded and the relationship of the time and the quantity of the commodity demanded.

According to Jain & Khanna (2011, p. 54) the main types of demands are:

• Price Demand, which expresses the relation between the price of a good and its demand. It is given by D=f (P);
• Income Demand, which expresses the relationship between income of the consumer and demand for a goodD=f(Y);
• Cross Demandwhich expresses the relation between demand for good ‘A’ due to a change of in the price of its related good ‘B’ D=f(P_b)

Qn.2 What factors determine the demand for rail transport in the UK?

A myriad of factors come into play when determining the demand for rail transport in the UK. These factors could be internal as well as external. Some of the key elements that influence this demand include:

Availability of substitutes to the rail system. This can come in the form of other modes of transport that are available to commuters in UK. If rail transport has close substitutes such as, air transport, bus and coach services, inland waterways, ferries, Taxis, Personal vehicle, changes in rail fares could result to significant changes in commuters making use of this form of transport. The presence of substitutes also presents Competition. Competitors are always seeking to own the bigger share of the market. This they achieve either through reduction of their prices or by differentiating their services or improving the service.

Income of the commuters: If the income level of commuters using the rail system is high, changes in rail fares will have an insignificant effect on the number of commuters using the rail transport, that is, changes in price will not affect the quantity demanded by a greater proportion. However, in low income groups, changes in the fare price will affect the demand for the rail system by a greater proportion. This is for the reason that the amount of income spent on fare does not constitute a big portion of the commuter’s income.

Price charged as rail fare: This is the most important factor that usually affects demand for any service or good. The law of demand indicates that an increase in price results to a decrease in quantity of a good demanded and vice versa. Therefore, an increase in rail fare price will in most cases result to a decrease in the quantity demanded.

Commuters taste and preferences. Changing tastes and preferences can have a significant influence on the demand for the rail services. Persuasive advertising is designed to trigger a change in tastes and preference for a particular service thereby creating an increase in demand. Thus, if the government increased it’s spending on advertisement on rail transport; this could translate to a change in commuter’s tastes and preferences and in extent increase the demand for rail transport.

The size and composition of the population using rail as their preferred mode of transport: If rail transport is the preferred mode of transport for a particular segment of the population, changes in the composition of the population that affects this particular segment of the population will result to adecrease or increase  in the demand for rail transport.

Fare Price charged by the other forms of transport available to commuters in the UK. If other forms of transport available to commuters in the UK offer lower or higher fares relative to the fare charged by rail transport, commuters being rational and faced with different producers who offer similar services they  will always opt for the provider that charges less.

Qn.3 What is meant by the price elasticity of demand?

Price elasticity of demand measures the responsiveness of demand of a good to a change in its price(Sexton, 2012, p. 154). Alfred marshal was the first economist to formulate the concept of elasticity of demand as the ratio of a relative change in quantity demanded to a relative change in price. Price elasticity is thus a percentage change in quantity demanded of a good to a percentage change in the product’s price. It is used to describe the sensitivity of consumption to changes in price. It refers to movement along its demand curve as its price changes. It is given by:

Following that the law of demand, price and quantity demanded show an inverse relationship, the price elasticity of demand is, in theory negative. But in practice and for simplicity, this quantity is always expressed in absolute value terms(Jain & Khanna, 2011, p. 53).

Demand can be elastic, inelastic or unitary elastic. Demand is elastic when the elasticity is greater than 1 (Ed>1). This implies that the quantity demanded changes proportionally more that the price changes. Asmall percentage change in price leads to a larger percentage change in quantity demanded. It is inelastic when the elasticity of less than 1. This implies that the quantity demanded changes proportionally less than the price changes. A change in price leads to a smaller percentage change in quantity demanded. This relationship is illustrated in the Graphs in Appendix 1.

Qn.4 The government is claiming the fares need to be increased in order to raise revenue to fund rail investment. Using your knowledge of the concept of price elasticity of demand, explain the reasons why this strategy might/might not succeed in raising revenue.

The strategy might ormight not be able toachieve the overall objective of raising revenue but this will to a large extent be determined by the price elasticity of the rail transport service. That is, total revenue can be only be determined by knowing the price elasticity of the demand for rail transport.When the price changes, the change in quantity sold may either increase or decrease the total revenue, depending on the elasticity of the service.

The total revenue will be the amount paid by the commuters and received by the government. It is simply given by the price of the good (p) times the quantity of the good sold (Q). If the price increases, it follows that total revenues will also increase. Total revenue is given by the shaded area:

If the demand for rail is price elastic (Ed>1), this implies that the demand for the rail transport is more sensitive to changes in price. Therefore, a small change in price results to a large change in quantities demanded. This has the effect of affect the quantity demanded it the opposite direction of the price. Therefore, if the demand for rail transport is price elastic, an increase in price, which the government is proposing will have a negative effect on the total revenues. Commuters will decrease their demand for rail transport by a bigger proportion than the increase in fare price. This has the overall effect of reducing the total revenue.

If the rail system has unitary elasticity (Ed=1), an increase in the price of rail fare will result to an equal decrease in demand.This has the overall effect of not having any effect on the total revenue. Therefore, if the demand for rail system is price inelastic, the government’s step to increase the rail fare price will result to a decrease in demand that is proportionally equal to the increase in rail fare price. Consequently, the total revenue will not change and the government will not have been able to raise the additional revenue that it had intended with the increase in prices.

On the other hand, if the demand for rail transport is relatively price inelastic (Ed>1), total revenues will change in the same direction as the price. This is because the price change more than compensates for the change in quantity. Therefore, raising prices increases total revenue.An increase in prices will result to an increase in revenue since the decrease in the demand for rail transport will reduce by a proportionately small percentage to the increase in price.If demand for the railway services is inelastic, an increase in price will cause the government to lose the revenue. They will however, experience an increase in revenue resulting in an overall increase in total revenue.

Therefore, only in the occasion that the government has ascertained that the price elasticity of demand is inelastic should they take the step of increasing the price of rail fare. This is because if the price elasticity of demand is elastic the government will lose total revenue, and if rail fare has unitary elasticity the government total revenues will not have changed.

References

Jain, T. R. & Khanna, O. P., 2011. Economics. New Delhi: VK Publications.

Sexton, R., 2012. Exploring Economics. 6 ed. s.l.:Cengage Learning.

Siddiqui, S. A., 2006. Managerial Economics And Financial Analysis. New Delhi: New Age International.

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