Elasticity of Demand: New York City Transit Authority Case Study, Slides of Managerial Economics

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ELASTICITY

CASE: NEW YORK CITY TRANSIT

AUTHORITY

 May 2003: projected deficit of $1 billion over following two years  Raised single-ride fares from $1.50 to $  Raised discount fares  One-day unlimited pass from $4 to $  30 - day unlimited pass from $63 to $  Increased pay-per-ride MetroCard discount from 10% bonus for purchase of $15 or more to 20% for purchase of $10 or more.

MANAGERIAL ECONOMICS

QUESTION

 Would the MTA forecasts be realized?  In order to gauge the effects of the price increases, the MTA needed to predict how the new fares would impact total subway use, as well as how it would affect subway riders’ use of discount fares.  We can use the concept of elasticity to address these questions.

OWN-PRICE ELASTICITY: E=Q%/P%

Definition: percentage change in quantity demanded resulting from 1% increase in price of the item. Alternatively, %_change_in_price %_change_in_quantity_demanded

CALCULATING ELASTICITY

 Point approach: Elasticity={[Q2-Q1]/Q1}/{[P2-P1]/P1} % change in qty = (1.44-1.5)/1.5= - 4% % change in price = (1.10-1)/1= 10% Elasticity=-4%/10%=-0.

CALCULATING ELASTICITY

 Point approach: Elasticity={[Q1-Q2]/Q2}/{[P1-P2]/P2} % change in qty = (1.5-1.44)/1.44= 4.16% % change in price = (1-1.10)/1.10=-9.09 % Elasticity=4.16%/-9.09%=-0.

OWN-PRICE ELASTICITY

 |E|=0, perfectly inelastic  0<|E|<1, inelastic  |E|=1, unit elastic  |E|>1, elastic  |E|=infinity, perfectly elastic

OWN-PRICE ELASTICITY: SLOPE

 Steeper demand curve means demand less elastic  But slope not same as elasticity

ELASTICITY ON LINEAR DEMAND CURVE

 Vertical intercept: perfectly elastic  Upper segment: elastic  Middle: Unit elastic  Lower segment: inelastic  Horizontal intercept: perfectly inelastic

Product Market Elasticity Automobiles Chevette U.S. -3. Civic U.S. - Consumer products music CDs Aus -1. cigarettes U.S. -0. liquor U.S. -0. football games U.S. -0. Utilities electricity (residential) Quebec -0. telephone service Spain -0. water (residential) U.S. -0. water (industrial) U.S. -0. OWN-PRICE ELASTICITIES

AMERICAN AIRLINES

“Extensive research and many years of experience have taught us that business travel demand is quite inelastic… On the other hand, pleasure travel has substantial elasticity.” Robert L. Crandall, CEO, 1989

AADVANTAGE

1981: American Airlines pioneered

frequent flyer program

 buyer commitment

 business executives fly at the expense of

others

FORECASTING

 Forecasting quantity demanded  Change in quantity demanded = price elasticity of demand x change in price

FORECASTING:

PRICE INCREASE

 If demand elastic, price increase leads to  proportionately greater reduction in purchases  lower expenditure  If demand inelastic, price increase leads to  proportionately smaller reduction in purchases  higher expenditure