S. Klepper, Economics 73-100, Fall 2011

Solution to Quiz 3

If the city decreased the bus fare, the quantity demanded of bus rides would increase and the number of riders would be expected to increase. Total revenues would rise, however, only if the price elasticity of demand for bus service were greater than one, in which case the city’s losses would decline. Alternatively, if the price elasticity of demand for bus service were less than one, the city’s revenues would decline and its losses would increase if it lowered the bus fare. The opposite applies to an increase in the bus fare—it would increase revenues and decrease losses if the price elasticity of demand were less than one and decrease revenues and increase losses if the price elasticity of demand were greater than one. In the intermediate case of a price elasticity of demand for bus service equal to one, a price increase or decrease would have no effect on total revenues and hence would have no effect on the city’s losses. The income elasticity of demand indicates nothing about the effect of a price change on the quantity demanded or total revenues.

Based on this description, the answers to the individual questions are:

_____1. True

_____2. False—it depends on the price elasticity of demand

_____3. False

_____4. True

_____5. True