A simple economic model predicts that a fall in the price of bus tickets means that more people will take the bus. However, you observe that some people still do not take the bus even after the price of a ticket fell

Question

a. Is the model incorrect?
b. How would you test this model?

Answer 1

a. The model is not incorrect. Models are only approximations of real-life behavior. Even very good models make predictions that are often correct. So, on average, more people will take the bus. The model is also likely to have made some assumptions, such as no change in costs of other types of transport, or that people have no specific preferences and cost is the only determinant of the mode of transport used. In reality, some of these assumptions may be violated which could explain why a fall in the price of bus tickets does not induce everyone to take the bus. That does not imply that the model's conclusion is incorrect. In situations where the assumptions it makes are satisfied, its prediction will often be correct.
b. The hypothesis here states that as bus prices fall, the number of passengers who take the bus will increase. A natural experiment can be used to test this model. You can use data on price changes and changes in revenues earned from tickets to see whether the model is accurate.