Question

If an increase in bus fares in Charlotte, North Carolina, reduces the total revenue of the public transit system, this is evidence that demand is a. price elastic. b. price inelastic. c. unitary elastic. d. perfectly elastic.

Short answer

The correct answer is a. price elastic. This is because the demand for bus rides in Charlotte, North Carolina is sensitive to changes in price, causing total revenue to decrease when bus fares increase. The decrease in total revenue is evidence of greater percentage change in quantity demanded compared to the percentage change in price, indicating that the demand is price elastic.

Step-by-step solution

1. Review the price elasticity of demand

Price elasticity of demand measures the sensitivity of the quantity demanded of a good or service to a change in its price. It is calculated as the percentage change in quantity demanded divided by the percentage change in price. Depending on the magnitude of price elasticity of demand, it can be classified into the following types: a. Price elastic: If the percentage change in quantity demanded is greater than the percentage change in price, the demand is price elastic. With a price increase, total revenue will decrease. b. Price inelastic: If the percentage change in quantity demanded is less than the percentage change in price, the demand is price inelastic. With a price increase, total revenue will increase. c. Unitary elastic: If the percentage change in quantity demanded is equal to the percentage change in price, the demand is unitary elastic. In this case, the change in the price will not affect the total revenue. d. Perfectly elastic: In this case, the demand is infinitely responsive to any price change. In other words, only a specific price will be accepted, and any change in price will lead to zero demand.

2. Apply the concept to the given situation

The exercise states that an increase in bus fares leads to a decrease in total revenue. This observation indicates that the percentage change in quantity demanded was greater than the percentage change in price. Thus, the demand for bus rides is price elastic.

3. Select the appropriate answer

Based on our analysis, given that the demand is price elastic due to the decrease in total revenue after a bus fare increase, the correct answer is: a. price elastic.

Key concepts

Elastic Demand

Elastic demand is a term used when the demand for a good or service significantly changes in response to a change in price. It means that consumers are quite sensitive to price alterations. In a scenario where the price of a product goes up, and the quantity demanded drops so profoundly that the overall revenue diminishes, this behavior exhibits elastic demand.

Understanding elastic demand is crucial because it can influence how businesses set their prices. If a company knows that their product has an elastic demand, they will be more wary about increasing prices, as this could lead to a substantial decrease in sales volume, negatively impacting their total revenue. Conversely, during price cuts, they could expect a significant increase in the quantity sold, potentially offsetting the reduced price point and leading to higher total revenue.

Inelastic Demand

In contrast, inelastic demand describes a situation where the quantity demanded of a good or service is relatively insensitive to changes in its price. With inelastic demand, consumers are not as likely to alter their purchasing behavior even if the price increases or decreases.

Products and services deemed necessities typically exhibit inelastic demand as individuals need to continue buying them, regardless of the price shifts. For instance, utilities like electricity and water are often considered inelastic because consumers will continue to use them even if prices rise. Companies dealing with inessential goods enjoy a more stable revenue stream even when prices change, which can be beneficial for budgeting and planning.

Unitary Elastic Demand

Unitary elastic demand occurs when there is a proportional relationship between price changes and demand changes. For each percentage point that the price goes up or down, there is an identical percentage change in the quantity demanded. This balance means that businesses see no change in total revenue when they modify their prices. In the real world, products with unitary elasticity are not as common because they assume a perfect one-to-one relationship between price change and quantity demanded.

For businesses, understanding whether their product falls into this category can be tricky. Strategizing around price adjustments requires careful market research because a slight deviation from unitary elasticity could tilt the scales towards either an increase or decrease in total revenue.

Perfectly Elastic Demand

Finally, perfectly elastic demand represents an extreme situation where consumers are only willing to purchase a product at one price point, and any deviation from this price can cause the demand to drop to zero. This scenario implies that there's an infinite sensitivity to change in prices - price increases are completely unacceptable, and consumers will immediately cease purchasing if a price uptick occurs.

In such markets, sellers have no power to change prices. They must accept the market price if they wish to sell their product. Perfect elasticity is an extreme and theoretical situation not often found in real-world markets but still serves as an important concept in economic theory to understand consumer behavior and market mechanisms.