Given that public transport generates external benefits, there is a strong case for subsidising non-private means of transport, such as bus, coach, tram and rail. The effect of a subsidy on public transport is to reduce the costs of supply to the provider.
Subsidies to public transport
A subsidy is likely to reduce public transport charges – in graphical terms, the supply curve will shift to the right, reducing the equilibrium price. This will lead to an extension of demand, as more people are encouraged to use this form of transport. The increased demand is the combined result of the income and substitution effect. At a lower price, alternatives to public transport appear more expensive (the substitution effect), and, assuming money income remains constant, cheaper public transport results in an increase in real income (the income effect).
Even with a large subsidy, travellers may prefer the convenience of private transport – implying that PED for public transport is inelastic. Research suggests that PED is, indeed, highly inelastic in the UK, with short run elasticities for bus travel, around (-) 0.4, tube travel (-) 0.3, and suburban rail (-) 0.6.
Cross elasticities are estimated to be even lower, with the cross elasticity of demand between bus fares and car travel just (-) 0.1, at best.
(Source: TRL Ltd, Demand for Public Transport – A Practical Guide, edited by J Balcolme, 2004)
In addition, the income effect of lower public transport prices may be very weak. Indeed, increases in real income may encourage greater use of private transport use, and discourage use of public transport, suggesting that public transport is an inferior good.
Subsidization of public transport may result in a moral hazard, with state subsidies being regarded as an insurance against inefficient practices. Such inefficiency raises the cost of supply, and diverts scarce resources from more efficient uses. For example, bus companies may over-employ, and operate too many buses, which are run at ‘half-empty’ for long periods.
There is, of course, no guarantee that all of the state subsidy will be passed on to the passenger in terms of lower fares.