Saturday, 1 November 2008

Remember this?

This question that mica dealt with and some of you tried to answer

This is what the Examiners said:

First of all, notice that your company is making a loss, so you need to take some action.The first piece of information you look at is the price elasticity of demand, where yousee that you face elastic demand, with the price elasticity being –1.58. So if you were to increase your fares by 10% (and if your company faced the same elasticity as theaverage for the market), you would expect to see a fall in demand of 15.8%, and a fall in revenues. On the other hand, if you were to reduce your fares by 10%, revenue would increase following a 15.8% increase in demand.

However, you need to be aware of market conditions. The economy is heading into a recession, and you are faced with an income elasticity of demand that is strongly negative (–2.43). In other words, bus travel is an inferior good. This is good news for you as it means that, as incomes fall in the recession, more people will use the buses, and you will enjoy an increase in demand.

Whether the cross-price elasticity will be helpful to you depends on what is happening in the market for rail travel. If you happen to know that rail fares are about to increase, then again this is good news for you, as bus travel is a strong substitute for rail travel.

For a 10% increase in train fares, there will be a 32.1% increase in the demand for bus travel. These elasticities thus help you to make a reasoned decision on pricing, depending on what is happening in the economy as a whole, and in the markets for close substitutes such as rail travel. The price elasticity of supply is less helpful to you. It tells you how you would respond to a change in price — but you probably know that anyway.

1 comment:

Approach to teaching

Methods there are many, principles but few, methods often change, principles never do