Answer to Question #176390 in Microeconomics for Abby Mbunda

Question

Your finance officer has just advised you that the public transport system faces a deficit. Your board does not want you to cut service, which means that you cannot cut costs. Your only hope is to increase revenue? Would a fare increase boost revenue? You consult the economist on your staff who has researched studies on public transportation elasticities. She reports that the estimated price elasticity of demand for the first few months after a price change is about-0.3, but that after several years, it will be about -1.5.

(a) Compute what will happen to ridership and revenue over the next few years if you decide to raise fares by 5%

Answer 1

Using the formula for price elasticity of demand and plugging in values for the estimate of price elasticity over a few years (−1.5) and the percentage change in price (5%), we can solve for the percentage change in quantity demanded as: 

e_D=$\frac{\Delta Q}{\Delta P}$

-1.5=$\frac{\Delta Q}{5}$

$\%\{\backslash Delta\; Q\}$ $\Delta Q=$ (-1.5×5%)

$\Delta Q$ =-7.5%

Therefore Ridership falls by 7.5% over a few years.