A local bus company is concerned about the increasing cost and fears it will make a loss. What should it do? The company surveyed to estimate passenger demand at three different fares: the current fare of $0.50 per kilometer, a higher fare of $0.60 per kilometer, and a lower fare of $0.40 per kilometer to help it decide what to do. The survey results are shown in the first two columns of the following table. Fare ($ per kilometer) Estimated demand (passengers millions) Old total cost($ millions per year) 0.40 6 1.8 0.50 4 1.8 0.60 3 1.8 Use the information given in the above table and apply your knowledge of the elasticity of demand to answer the follo(ii) Compute the total revenue per year at the given fares. Calculate the firm’s profit given the current fare of $0.50 per kilometer. Was the $0.50 per kilometer fare the best fare originally? Provide complete work and an explanation of your answer.wing questions.

Answer

The local bus company can use the elasticity of demand to determine the best fare option to maximize their profits. The elasticity of demand measures the responsiveness of the quantity demanded to a change in price. The company surveyed passengers at three different fares to estimate demand and calculate the total cost and total revenue.

Calculating Total Revenue

The total revenue per year can be calculated by multiplying the estimated demand (in millions) by the fare ($/km). For the fare of $0.40/km, the total revenue would be 6 million passengers x $0.40/km = $2.4 million per year. For the fare of $0.50/km, the total revenue would be 4 million passengers x $0.50/km = $2 million per year. For the fare of $0.60/km, the total revenue would be 3 million passengers x $0.60/km = $1.8 million per year.

Calculating the Firm’s Profit

The firm’s profit can be calculated by subtracting the total cost from the total revenue. The total cost for each fare is the same at $1.8 million per year. At the current fare of $0.50/km, the total revenue is $2 million per year, so the firm’s profit would be $2 million – $1.8 million = $0.2 million per year.

Was the $0.50/km Fare the Best Fare Originally?

No, the $0.50/km fare was not the best fare originally. The total revenue is higher for the $0.40/km fare at $2.4 million per year and for the $0.60/km fare at $1.8 million per year. The $0.50/km fare produces the lowest total revenue at $2 million per year. Therefore, the $0.50/km fare is not the best fare option for the local bus company.

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