Question

Managers of the New Hope and Ivyland Short Line Railroad conducted and experiment in which they reduced fares by about 28% for approximately a year to estimate the price elasticity of demand. This large fare reduction resulted in essentially no change in the railroad’s revenues.

Take a face value, what seemed to be the price elasticity of demand?

Answer 1

Price elasticity of demand refers to the responsiveness of change in demand for a good due to change in its price.

There are three main types of price elasticity of demand:

Elastic demand: With elasticity value greater than 1, it means a change in P leads to a more than proportionate change in Q. In this case, as P changes, total revenue also changes, but in opposite direction

Unitary elastic demand: With elasticity value equal to 1, it means a change in P leads to equally proportionate change in Q. In this case, as P changes, total revenue remains unchanged

Inelastic demand: With elasticity value less than 1, it means a change in P leads to a less than proportionate change in Q. In this case, as P changes, total revenue also changes, but in same direction

In the given case, a change in fare led to no change in total revenues.

This implies the railroad has unitary elasticity of demand, where in price elasticity of demand = -1

This is because with a change in fare price, quantity demanded changes equally proportionately, leaving TR unchanged.