Elasticity: A Measure of Response

Read this chapter to learn about the concept of elasticity. Be sure to read Sections 5.1-5.4 following the introduction.

The Price Elasticity of Demand

Try It

You are now ready to play the part of the manager of the public transit system. Your finance officer has just advised you that the 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.

  1. Explain why the estimated values for price elasticity of demand differ.
  2. Compute what will happen to ridership and revenue over the next few months if you decide to raise fares by 5%.
  3. Compute what will happen to ridership and revenue over the next few years if you decide to raise fares by 5%.
  4. What happens to total revenue now and after several years if you choose to raise fares?