Question

A city has built a bridge over a river and it decides to charge a toll to everyone who crosses. For one year, the city charges a variety of different tolls and records information on how many drivers cross the bridge. The city thus gathers information about the elasticity of demand. If the city wishes to raise as much revenue as possible from the tolls, where will the city decide to charge a toll: in the inelastic portion of the demand curve, the elastic portion of the demand curve, or the unit elastic portion? Explain.

Short answer

In the inelastic section of the demand curve, it should impose a toll. If the city wants to make the most money from tolls, it must choose to charge a toll in the inelastic region of the demand curve.

Step-by-step solution

Step1:Definition

Price Elasticity of Demand: The top half of a product's demand curve is elastic. The center section is unit elastic after this. The final section is rigid. Various sections of the curve have different pricing decisions.

Step 2:Explanation

When demand is inelastic, a given percentage increase in price causes a lesser percentage drop in quantity, resulting in an increase in total revenue (PxQ).

If toll is imposed on the elastic portion of the demand curve, the demand is likely to decline to a greater extent because of the change in price. In the unit section, the toll would cause proportional decline in demand. If toll is imposed on the inelastic portion, the decline in demand would be lowest.

Conclusion

This means that it would be most profitable to charge a toll on the inelastic section of the demand curve.