The Urban Transit Authority receives the following two pieces of expert advice:
1. “You should cut rail fares in order to encourage greater use. Raising fares will mean fewer customers and lower revenue.”
2. “You cannot afford to cut fares as this will reduce your revenues”
(a) What does each of these pieces of advice assume about the elasticity of demand for rail use?
(b) How might an economist seek to resolve the conflict of opinion?
(c) What factors determine the elasticity of demand for rail use?
(a) The first piece of advice assumes that the demand for rail use is relatively elastic. This means that a decrease in rail fares would result in a significant increase in demand and attract more customers, resulting in higher revenue through increased ticket sales. The second piece of advice assumes that the demand for rail use is relatively inelastic. In this case, reducing fares would not significantly increase the number of customers, leading to a decline in revenue.
(b) An economist might seek to resolve the conflict of opinion by conducting empirical research to estimate the elasticity of demand for rail use. This could involve analyzing data on past fare changes and corresponding changes in ridership and revenue. Additionally, conducting surveys or experiments to gauge customer responsiveness to price changes could also help determine the elasticity of demand.
(c) Several factors can influence the elasticity of demand for rail use. These include:
1. Availability of substitutes: If there are alternative modes of transportation, such as buses or private cars, that are perceived as reasonable substitutes for rail travel, the demand for rail use could be more elastic as customers can easily switch to these substitutes in response to price changes.
2. Time horizon: In the short run, demand for rail use may be relatively inelastic as customers may not have immediate options for alternative transportation methods. However, in the long run, customers may have more flexibility to adjust their travel choices, making the demand more elastic.
3. Income levels: The demand for rail use might be more price-sensitive for lower-income individuals, making it relatively elastic. Higher-income individuals may be less price-sensitive and have more fixed preferences for rail travel, leading to a relatively inelastic demand.
4. Distance and necessity: The elasticity of demand can also depend on the distance of travel and the necessity of the trip. Longer-distance travel may have more elastic demand, as customers have more alternatives available. Similarly, if rail travel is perceived as a necessary means of transportation, demand might be less elastic.
Understanding these factors and conducting empirical analysis can help economists estimate the elasticity of demand for rail use and make informed decisions regarding fare adjustments.