Question

The cab fare in Horseville is regulated. Recently, the government decided to raise it from $2.00 to $2.50 per ride. After this rise in fare, cab ridership decreased by 10 percent. a) What is the price elasticity of demand for cab rides in Horseville? Explain your answer             (10 marks) b) According to your estimate, what happened to the cab drivers' revenue after the fare rose? Explain.          (5 marks) c) Why might your estimate of elasticity be inaccurate?

Answer 1

a. Percentage change in demand = - 10%

Percentage change in price = (new price - initial price)/average of price * 100

= (2.50-2.00)/{(2.50+2.00)/2}*100

= 0.50/2.25*100

= 22.2%

Price elasticity of demand = (-) Percentage change in demand/ Percentage change in price

= (-)(-)10%/22.2%

= 0.45 < 1

Demand for rides is inelastic.

b. Revenue increases, if the demand for rides is inelastic (Percentage increase in price > percentage decrease in demand)

c. Estimate of elasticity could be wrong because in the question Percentage change in demand is already which might be obtained proportionately .I. e

(New demand - initial demand)/initial demand * 100

Here, the percentage change is calculated by taking the average if price, i.e., the difference in price/average of price * 100.