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You have been hired by the city to determine whether or not an increase in the price of...

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yaga49 | (Level 1) Valedictorian

Posted April 23, 2013 at 2:35 PM via web

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You have been hired by the city to determine whether or not an increase in the price of tickets for the mass transit system would raise system revenues.  The debate has been heated and the city council seems to be divided.  One side argues that in order to increase revenues from the transit system, prices must be increased.  The opposing side argues that a price increase at this time will lower revenues.  What assumptions are each side making about the price elasticity of demand?

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pohnpei397 | College Teacher | (Level 3) Distinguished Educator

Posted April 23, 2013 at 2:42 PM (Answer #1)

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Each side of this debate is assuming something different about the price elasticity of demand.  One side thinks that demand will be elastic while the other thinks that demand will be inelastic.

Demand for a good or service is elastic if the revenue that can be gotten by selling it drops when the price goes up and goes up when the price drops.  In other words, if people are sensitive to changes in price, demand is elastic.  If, on the other hand, they keep buying nearly the same amount of the product even as the price changes, the demand for that good or service is inelastic.

If the demand for tickets on the mass transit system is elastic, the thing to do is to reduce prices.  As prices drop, there will be enough of a corresponding increase in the quantity demanded and revenues will rise.  If demand is inelastic, the thing to do is to raise prices.  People will still buy enough tickets (the quantity demanded will not drop very much) so that the overall revenue will increase.

Thus, this is a debate about whether demand for mass transit tickets is elastic or inelastic.

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