A subsidy of 5% on bus and underground fares will act to change the market price signals for transport in London.

The introduction of a subsidy on public transport will reduce the price of public transport (bus and underground). The lower price relative to private car use will encourage utility maximising consumers to switch towards the lower priced substitute good. All other things remaining equal (ceteris paribus) this should reduce the quantity of vehicles on the road and the level of congestion.

( Disclaimer Statement : Note the following is a very broad statement that has been used for educational purposes to illustrate theory. The actual relationship may not always hold due to the complexities of the issues. Therefore, it may not always be taken literally in practice.)

The problems with this policy stem from issues relating to the size of the change and the wider implications on the economy.

• The policy may not be very successful because private car use and bus/underground travel may not be very close substitutes (CPED is less than 1). Therefore, the large change in price may have little effect on the quantity demanded.
• The subsidy will need to be financed by government. The higher expenditure within budgetary constraints results in either an increase in taxation or a shift of resources from other expenditure areas such as education. Either of these may have adverse consequences on the macro economy.

A subsidy will have the effect of reducing bus and underground fares. The default level of fares is set at no change in the model. However, they can be cut by up to 50%.

University students can apply their knowledge of indifference curve analysis to illustrate changes in consumer behaviour as a result of the imposition of transport subsidies. How will the consumer equilibrium change when subsidies are implemented? What will shift - the indifference curve or the budget line?

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