Question 1: The UK Rail Industry

(a) Using supply and demand analysis, state what could have caused the changes in annual
rail fares and annual passenger numbers in Table 1. [2]

• Assuming the SS of rail services remains constant, the greater population in UK

could lead to an increase in demand for UK rail service → shortage and upward
pressure on rail fares → annual rai fares increased
• The increase in demand for UK rail services also saw an increase in the number of
annual passenger number
OR
• Greater population could lead to an increase in DD.
• At the same time, there could be an increased in the frequency of rail services. OR
At the same time, privatisation might have led to rail companies reducing the SS of
rail services.
• Increase in DD > change (increase or decrease) in SS → shortage and upward
pressure on rail fares → annual rai fares increased & increase in the number of
annual passenger number

(b) With reference to Table 2, comment on whether the UK government should subsidise rail
transport or bus to reduce private car usage. [4]

Impact of subsidies on fares

• If subsidy is given to the producers of public transport (rail transport or bus
transport), it will lower the COP → increase the SS of public transport → surplus of
public transport services → downward pressure on public transport fare → fall in
public transport fare. The fall in public transport fare could prompt private car owners
to switch from using private cars to cheaper substitutes such as rail or bus.

UK govt may want to consider subsidising rail transport

• However, the XED value for car w.r.t rail (XED = 0.196) is higher than XED value
for car w.r.t bus (XED = 0.116). DD for car w.r.t rail is less positive cross inelastic
than DD for car w.r.t bus.
• This suggests that qty dd for car is more responsive to a change in price of rail than
bus. The fall in rail fare → fall in DD for car as drivers switch to rail. This fall in DD
for car is likely to be more when rail fare fall compare to a fall in bus fare.
• Thus to reduce car usage, govt may want to subsidise rail transport instead of bus
as car users are more responsive to a fall in fares of rail than bus.

Comment
• However, government may also want to subsidise bus fares as well.
• Since the XED for car w.r.t. bus is positive, indicating that both goods are
substitutes, a fall in bus fare will still prompt car users to switch to bus especially in
cities/areas with the parked and ride scheme. Such scheme may further help drivers
to switch from cars to bus.
OR
• In addition of reducing the fares of substitutes of car, govt could also increase the
cost of owning a car which may reduce the private car usage.

(c) Extract 1 explains that the UK government is considering building the High-Speed 2
(HS2) rail network to improve rail connections in the country.

(i) Explain a possible opportunity cost that the government might incur in the building
of HS2 rail network. [2]

• Opportunity cost is the value of the next best option forgone.

• If UK government build the HS2, the government might have forgone the
benefit of spending on higher education such as a making UK a more attractive
place for FDI.

(ii) Discuss the factors that the government needs to consider in their decision to build
the HS2 rail network. [8]

Introduction
Briefly explain the factors that government needs to consider:
• Cost and benefit of building the HS2
• Constraints face when building the HS2

Body Paragraph 1: Benefit

UK government needs to consider the benefit of building the HS2 rail network.
• Extract 1 suggests that construction of infrastructure like HS2 could have a
stronger positive effect on growth and employment than spending on
consumption goods.
• Building HS2 → increase in investment in infrastructure by govt → increase in
AD
• At the same time, construction of HS2 also triggered associated development
(extract 1) such as investment in capital goods by construction firms →
increase AD as seen in the diagram below.
• The increase in AD → increase in NY by multiple times due to the multiplier
effect, assuming there is spare capacity.
• Increase in AD → increase in employment especially in a wide range of
industrial sectors from the construction sector to the civil engineering and rail
industries (Extract 1). This reduces the demand deficient unemployment in the
country.
• Economic growth and lower unemployment could mean that higher income tax
revenue collected and fewer unemployment benefits given to the citizens →
reduce the government debt
• At the same time, increase spending on infrastructure for HS2 → increase in
quantity of capital goods → increase the productivity such that workers could
travel longer distance within a shorter time and more goods can be delivered
given the time period → maximum output that UK can produce increase → this
 increase productive capacity of the country → increase in LRAS → prevents
any potential DD-pull inflation if the country is near full capacity
Thus, construction of HS2 could bring about macroeconomic benefits to the
country.

Body Paragraph 2: Comment on the benefit

• Construction of HS2 has benefit both in the short and long run.
• Such benefits, economic growth and lower unemployment, would be especially
beneficial if UK is experiencing slow EG in the country. Such expansionary
policy may help to prevent slow EG and rising unemployment.
• However, UK government should not just look at the benefit of HS2.
Constructing such mega project will definitely incur cost. Thus, government
must also consider the cost of constructing the HS2.

Body Paragraph 3: Cost

Construction of HS2 has significant cost and govt needs to take into consideration
the cost of building HS2.
• The UK govt could incur substantial construction cost, such as compensation
for disruption during the construction work being paid to residents staying near
construction sites, to major expenses arising from a resulting need to expand
and upgrade existing stations that are going to link to the HS2 (extract 1).
• Residents living along the proposed HS2 route will suffer from years of
disruptive construction work, followed by up to 28 trains an hour screaming
past their homes and villages at speeds of up to 400km/h (extract 1).
Note: not a MEC because UK government has compensated the residents for
the disruptive construction work and pollution caused by the HS2.
• The building and running of HS2 generates noise pollution, affecting the quality
of life of the residents and increasing the stress of the residents. Housing value
near the construction site and HS2 track could fall, reducing the possible
wealth of the residents.
Thus construction of HS2 will have substantial cost on both the government and
residents living near the construction site.
Body Paragraph 4: Comment on the cost
• The cost of building HS2 may be substantial given the scale of the project.
However, government has to consider both the cost and benefit before
deciding on the project.
• While the HS2 requires substantial financial cost, if the construction and
operation of HS2 generates sufficient revenue for the government so much so
that the revenue can cover the cost, government can consider constructing the
HS2 rail network.
• However, the cost and benefits are estimations provided by the government
and economic agency such as IEA (Extract 1). The accuracy of such estimation
is restricted by the available information that government and economic
agency have. Furthermore, the information gathered and presented by the
respective organisations could be biased, deliberately skewed in favour of their
argument.
• Thus, the cost and benefit may be under/overestimated. Therefore, when
government makes decision, the government needs to take into account the
constraints which include the availability and accuracy of data.

Body Paragraph 5: Constraints

Government needs to take into consideration the possible constraints they might
face when deciding on the HS2 rail network.
• Extract 1 suggests that estimation of the cost and benefits may not be accurate
and that government may have under-estimated the cost while over-estimating
the benefits. Thus, government needs to recognise that the availability and
accuracy of information may affect their decision-making.
• Added to the lack of information and accuracy of information, the limited funds
might restrict or constrain the decision to build HS2.
• UK has rising government debt and this might prevent government from
implementing the HS2. The high and rising government debt would also mean
that UK government will face greater difficulty in borrowing funds for their
spending and this would further restrict access to funds to build HS2.
Thus, government will also have to consider the constraints they face when
deciding whether to build HS2.

Conclusion
• Government will have to consider the cost and benefit of building the HS2 as
well as the constraints they face.
• If the cost is within the constraints, the government can consider the HS2
project. For example, if the cost of building the HS2 is within their limited
budget, the UK government could consider the project.
• And if there is net benefit, where the cost is at least equal or less than the
benefit, the UK government should build the HS2 rail network.
• UK government also need to consider not just current cost and benefit, but also
future cost and benefit. If future revenue could more than pay off the cost of
 constructing the HS2 and repay any loans made to finance the project, then
the government might want to consider constructing the HS2.

Level Descriptor Marks

• Well-developed analysis of the factors government needs
to consider in their decision to build the HS2 rail network.
L2 4–6
• Good use of evidence from the extract.

• Superficial analysis of the factors government needs to

consider in their decision to build the HS2 rail network.
L1 • No evidence or inadequate evidences cited or evidence 1–3
cited incidentally.

• Make a reasoned judgement on UK decision to build the

E 1–2
HS2 rail network.

(d) Explain whether the UK rail ticketing strategies could be considered an example of price
discrimination. [4]

Price discrimination is the practice of firm charging a different price for the same
product when the price difference cannot be explained by differences in costs of
production.

Example of price discrimination

Advance tickets
• Travellers who are buying ‘Advance’ tickets are planning ahead. This group of
travellers has the option of buying early (‘Advance’ tickets) or buying just before
boarding the rail. They could buy ‘Anytime’ tick if they want to travel anytime or buy
‘Off-peak’ tickets if they are travelling during off-peak hours.
• Given the various options available, travellers have many substitutes to choose
from. Thus, their demand is more price elastic compare to other groups of traveller
→ ‘Advance’ travellers are charge a lower price.
• It is also possible to identify the ‘Advance’ travellers as this group of travellers are
buying their tickets in advance (up to the day before the day of travel).
• Resale of ‘Advance’ tickets is not possible as the ticket would include the name,
time and destination of travel. Thus, it is impossible for travellers to buy ‘Advance’
ticket at lower price and sell it at higher price to another traveller.
• There is no different COP as the ‘Advance’ travellers will be enjoying the same rail
service as other group of travellers such as travellers travelling using the ‘Anytime’
tickets.

OR

Anytime tickets
• Travellers who are buying the ‘Anytime’ tickets could be individuals who need to
travel at short notice because of sudden emergency or a business meeting called
at the last minute. Such last-minute travellers have a more price inelastic demand
→ ‘Anytime’ travellers will be charged a higher price
• It is also possible to identify the ‘Anytime’ travellers as this group of travellers will
not be buying their tickets in advance and likely to buy them at the last minute or
any time of the day of their travel.
• Resale of ‘Advance’ tickets is not possible as the ticket would include the name,
time and destination of travel.
• There is no different COP as the ‘Anytime’ travellers will be enjoying the same rail
service as other group of travellers such as travellers travelling on ‘Advance’ tickets.

Not an example of price discrimination

Higher price for indirect route ticket
• Ticket prices for indirect route is higher and this could be attributed to the higher
COP
• Indirect route requires travellers to switch to another rail, with the possibility of
multiple stops → thus there could be longer travelling distance and thus higher COP
→ higher ticket prices

OR

Higher prices for First Class Anytime ticket

• Ticket prices for First Class Anytime is higher and this could be attributed to the
higher COP
• Travellers who buy first class tickets are offered additional free Wi-Fi,
complementary food and drinks. There is higher COP when Wi-Fi, food and drinks
are offered to the consumers. Thus, the higher COP is passed on to the consumers
in the form of higher prices.

(e) Discuss whether UK should renationalise or to adopt Japan’s model of privatisation of its
rail network. [10]

Introduction
Briefly explain current UK’s mode of privatisation
• Railway is split up along regional line
• Govt breaks up railway operations into three components: tracks, trains, and train
operations. Each component is owned by different private companies.
Briefly explain the two options available for UK rail network
1. Renationalise: government to take over all the operation (tracks, trains and train
operation) of UK rail network
2. Japan’s model of privatisation: railway is split up along regional line and all operation
(tracks, trains and train operation) is owned by private company

Body Paragraph 1: Using profit to improve services

UK might want to consider renationalise the rail network instead of adopting
Japan’s model of privatisation of its rail network because it allows the UK
government to keep the profit and use it to improve the quality of service
• Under privatisation system, foreign firms could own the rights to operate the regional
line. These foreign firms are actually owned by foreign governments (Extract 2).
• Since foreign governments (Extract 2) own foreign firms, UK government might as
well take over the operation and renationalise the rail network instead.
• Given that foreign governments operate some regional rail network, any profit
earned would likely be sent back overseas to fund their countries’ government
spending (Extract 3). Thus, it might be more beneficial if UK government operate
the rail network and keep the profit in UK as part of their government revenue. This
could reduce the outflow under the primary income balance in the current account,
improving the BOP.
• If government renationalise the rail network, the profit earned from rail operation
could be reinvested in the rail transport to ensure quality rail services. This is unlike
privatisation where private rail operators may not invest in new trains as seen in
Extract 2 that about a third of passengers are standing during rush-hour train
services in London. Thus renationalisation could reduce such problem.
Thus, renationalisation of the rail network might be a better option.

Body Paragraph 2
• However, this benefit is assumed that there is profit to be earned from rail operation.
Whether there is profit to be earned depends on government’s management
because there is a possibility that UK government may face rising cost due to
complacency or lower revenue due to lower fares charged.

Body Paragraph 3: Allocative efficiency and lower prices, higher output

UK might want to consider renationalise the rail network instead of adopting
Japan’s model of privatisation of its rail network because the government could
charge a lower fare and produce at higher output.
• Under Japan’s model of privatisation, fares have never risen once in 31 years,
except once when there was a consumption tax hike (Extract 3). It may suggest that
Japan’s model of privatisation is successful in keep rail fares constant over 3
decades. But it may be worthwhile to also consider the cost of providing rail services
in Japan.
• There could be a possibility where cost of producing rail services is falling yet fares
are constant. Over the past 31 years, technology has improved tremendously with
faster and larger trains. And trains are getting more and more energy efficient →
reducing the cost required to provide rail services. Furthermore, rail companies are
also able to better exploit iEOS → reducing the AC as the cost is spread over a
larger output.
• If cost of producing rail services is falling and yet rail fares are constant, it could
suggest that private rail companies are not passing the cost saving to consumers in
the form of lower price. Thus renationalisation would be a better option, as UK
government could pass the cost saving to the consumers in the form of lower price.
• Furthermore, under Japan’s model of privatisation, private firms would maximise
profit at MC=MR and produce at output Qm. At that output, rail fares would be Pm,
which is higher than MC. Thus under the model of privatisation, firms would be
allocative inefficient and charge a fare that is higher than MC, even though rail fares
have not risen.
• However, should UK government choose to renationalise it, the government could
adopt AC-pricing or MC-pricing.
• With MC or AC-pricing, the fare charge would be lower than the fare charged by
profit maximising private firms and output would be higher than profit maximising
level, Qm.
• Should government choose MC–pricing, the government could charge fares at P =
MC and produce rail services at the allocative efficient level.
• Since government’s aim is not to maximise profit, they would be more willing to
provide rail services to less popular areas/routes. Unlike privatisation, profit
maximising rail companies may not be keen to provide rail services to these areas
given that the companies could earn subnormal profit in the long run.
Thus, re-nationalisation would have been a better option than Japan’s model of
privatisation.

Body Paragraph 4
• If government aims to lower pricing by charging P=MC, the government owned rail
company will be earning subnormal profit.
• Thus, government may need to subsidise the company → increase government
spending → could worsen the UK government debt.
• However, lower fares would reduce inequity, ensuring that low income group has
access to public transportation.

Body Paragraph 5: Efficiency and Prices

UK might want to consider Japan’s model of privatisation of its rail network
instead of renationalisation.
• When government renationalise the rail network, government intends to be the sole
provider, with no intention of allowing new company to enter the market. Thus, the
market is not contestable. Given this, government could be complacent and less
likely to find the most cost efficient way of providing rail services. Thus, there is a
possibility of X-inefficiency.
• Cost of producing the rail services may be higher → fares maybe higher instead.
• However, under the Japan’s model of privatisation, government sold the rights to
run the region railway to private companies. The market would be more contestable
as new firms could win the right to operate the marker. Thus, private firms might aim
to produce at the lowest cost possible → the fares would be low. This is evident in
Extract 3 where it mentions that fares in Japan have never risen once in 31 years,
except once when there was a consumption tax hike.
Thus, UK might want to consider Japan’s model of privatisation as it could prevent X-
inefficiency.

Body Paragraph 6:
• However, it is worthwhile to note that under Japan’s model of privatisation, it could
create a monopoly. If UK government decided to adopt Japan’s model, UK
government must ensure that the market remains contestable so that the private
firms will minimise cost and pass them on to the consumers.

Body Paragraph 7: Innovation

UK might want to continue with privatisation of its rail network instead of
renationalisation as privatisation may bring about innovation in the rail industry.
• Privatisation allow private companies, both domestic and foreign, to bid for the right
to operate the rail services. This allows for rail companies from around the world to
bring new ideas and innovation to Britain’s railways (Extract 2).
• Transport companies all over the world are using big data treatment to better
understand travellers travelling patterns. This helps rail companies to better plan
their rail services. This could be in the form of whether to increase/decrease the
train frequency.
• Thus, under the privatisation model, private companies could transfer such ideas
from other countries into UK, something that may not happen if the rail service is
renationalised and owned by the UK government.
Given the benefit of privatisation, government should consider privatisation instead.

Body Paragraph 8:
• While privatisation could bring about innovation, it really depends on the willingness
of private firms to carry out the innovation. Even if firms are willing to carry out
innovation, it may be at the cost to the government.
• According to Extract 3, firms are seeking subsidies from government to improve
their services despite the fact that the firms are earning profit.

Conclusion
• Current model of privatisation is not efficient and fares are rising. Thus, there is a
need for government to make changes to the existing rail industry.
• Rather than debating whether renationalisation or Japan’s model of privatisation is
better, it might be helpful for the UK government to first examine the problems in the
UK rail industry and identify the root cause of the problems before implementing the
right solutions to the problems.
• UK government might not necessary choose one of the two options proposed
(renationalisation or Japan’s model). UK government might instead keep the
existing model of operation but implement changes that could solve the existing
problems.
• For example, the rising rail fares may not necessary be a result of privatisation. It
could be caused by rising COP such as rising wages and oil prices.
• It might also be worthwhile to note that under Japan’s model of privatisation, the
constant fares could be due to falling/stagnant cost of production. Inflation is Japan
is close to zero, suggesting that COP could be stagnant and thus there is no need
for the firms to increase the fares. Unlike UK, the country saw healthy inflation for
the past few years, indicating rising COP. Thus, the rising fares.
• Thus, it may not be accurate to state that Japan’s model is better base on the fact
that Japan’s rail fare has been constant for 31 years.

Level Descriptor Marks

L2 • Well-developed analysis on whether UK should renationalise
or to adopt Japan’s model of privatisation of rail network.
• Good comparison between renationalisation and Japan’s
5–7
mode of privatisation of rail network.
• Good use of evidence from extracts to support the answer.

L1 • Superficial analysis whether UK should renationalise or to

adopt Japan’s model of privatisation of rail network.
• Weak/no attempt at comparison between renationalisation and
Japan’s mode of privatisation of rail network. 1–4
• No evidence or inadequate evidences cited or evidence cited
incidentally

E2 • Judgement is based on analysis that reaches a conclusion

based upon the analysis offered. 2–3

E1 • Judgement is may not be supported by analysis.

1