Economics Year 1 Elasticity In the Activity, the following abbreviations are used:

● Ped = Price Elasticity of Demand

● Pes = Price Elasticity of Supply

● Yed = Income Elasticity of Demand

● Xed = Cross Elasticity of Demand

● Δ = change

Task 1 Calculate the price elasticity of demand in each of the following examples:

● The change in demand is 5%, the change in price is 7% 5% / 7% = 0.71 inelastic

● The change in demand is 12%, the change in price is 3% 12% / 3% = 4 elastic

● The change in demand is 9%, the change in price is 4% 9% / 4% = 2.25 elastic

● The change in demand is 13%, the change in price is 25% 13% / 25% = 0.52 inelastic

● The change in demand is 6%, the change in price is 8% In each case say whether the price elasticity is inelastic or elastic. 6% / 8% = 0.75 inelastic

Task 2 Calculate the percentage change in demand in each of the following cases:

Where appropriate say whether the good is a normal good or an inferior good, or whether it is a substitute or complement.

● Yed is 2.4 and the % Δ P is 5%

2.5 x 5%= 12.5% Normal good

● Xed is -1.5 and the % Δ Price of good y is 20%

1.5 x 20% = 30% complement good

● Ped is -0.6 and the % Δ P is 18%

0.6 x 18% = 10.8% complement good

● Pes is 1.2 and the % Δ Pis 6%

1.2 x 6% = 7.2% substitute good

● Yed is -3.1 and the % Δ Pis 8%

3.1 x 8% = 24.8% inferior good

Task 3 In each of the following cases say whether the goods are substitutes or complements and whether the relationship is elastic or inelastic:

● Xed = -2.3 This is a complement good and elastic relationship

● Xed = -0.6 complementary good and inelastic relationship

● Xed = +4.1 substitute goods with an elastic relationship

● Xed = -1.67 complementary goods with an elastic relationship

● Xed=+0.74 substitute with an inelastic relationship

Define SPLAT: They are determinants of PED. Substitutes, percentage of income, luxury or necessity, addition and times.

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Elasticity: Toll Roads - ActivityThe Birmingham Northern Relief Road (BNRR)

Anyone who has to travel on the M6 north or south along the section that links with the M40 and M5 will know that it is highly congested, to say the least. The average speed of vehicles using this section was estimated to be around 17 mph; workers in the RAC's regional operational centre at Walsall in the West Midlands, which overlooks the M6, reckon they can set their watches to the time when queues will start to build on Junction 8 of the M6 and M5. The road was originally designed to carry 72,000 vehicles per day; currently over twice that many use the road.

W i t h t h i s p r o b l e m i n m i n d , t h e D e p a r t m e n t f o r T r a n s p o r t c o m m i s s i o n e d t h e B i r m i n g h a m Northern Relief Road (BNRR) - 27 miles of 3 lane motorway linking the M42 south of Birmingham with the M6 to the North. The road cost £485 million and was opened in December 2003.

What is unusual about this motorway is that it is the first toll motorway in the UK. The tolls are operated by a company called Midland Expressway Ltd. Midland Expressway initially announced the charges for the tolls as follows:

● Cars - £3 during the day and £2 at night (11.00pm - 6.00 am)

● Heavy Goods Vehicles (HGVs) - £11.00 during the day and £10 at night On 13th August 2004, the 10 millionth customer paid their toll. The lucky driver was given a trip to Portugal! The initial opening period saw prices discounted (cars were £2) but the standard prices initially quoted were then applied (they now stand at &3.50 for a car during the day, and &2.50 at night). Midland Expressway also announced that for a five-month trial period from July 2004, HGVs would receive a discount of £6 during the day and £5 at night.

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��� ���Image: Reproduced by kind permission of CAMBBA Construction Group, M6 Toll Project Office, Off Watling Street,Shenstone,Staffordshire W S 1 4 O G B h t t p : / / w w w . m 6 t o l l . c o . u k

What price to charge for the toll may have been decided by considering a number of factors:

● The cost of building the road

● The expected usage of the road and therefore the time taken to 'break even'

● The cost of maintaining the road

● The price elasticity of demand for road use

● The cross price elasticity of demand for other roads

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��� ���Image: Toll booths on the M6 toll road. Copyright: Ian Britton, F reeFoto.com.

We are going to focus on the latter two factors. Clearly the aim of building the motorway was to

relieve congestion on the M5/M6. In order for this to happen, enough people have to be

p e r s u a d e d t o u s e t h e n e w m o t o r w a y e v e n t h o u g h b y d o i n g s o t h e y w i l l i n c u r s o m e p r i v a t e c o s t .

Charge too high a price and people will avoid using the road, too low a price may not generate

enough revenue to make a profit. An example may serve to highlight this:

The Golden Gate Bridge spanning San Francisco Bay in the United States is a toll bridge. In

September 2002, the toll was increased from $3 to $5 (£1.80 - £3.00). As a result, demand fell

by 82,000 over the next three months but revenue rose by 45%!

(Source: B ob Melrose, KCBS News)

Image: The Golden Gate Bridge

The decision by Midland Expressway Limited to set different prices for the daytime and for the night time may be influenced in part by an attempt to encourage people to use the road during the night time, when it is less busy. Studies in Spain suggest that the price elasticity of demand for tolls range from -0.2 to -0.3 but, if there were alternative routes available, this could be as

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��� ��� h i g h a s - 0 . 8 3 . ( S e e T h e D e m a n d E l a s t i c i t y o n T o l l e d M o t o r w a y s b y A n n a M a t a s a n d J o s é - L u i s Raymond [PDF, 515 KB].) That same study estimates the price elasticity of demand for petrol as being between -0.34 and -0.53.

Questions

Given all the information above, consider the following questions:

1. What could you conclude about the price elasticity of demand for the use of the Golden Gate Bridge in San Francisco? Explain your reasoning. ( 8 Marks)

Since the price of the use for the Golden Gate Bridge increases, the demand for it decreases and total revenue increases, this means the PED is inelastic.

Seeing it in the equation for PED, the numerator is smaller than the denominator, so the value of PED will be smaller than 1.

2. Examine the impact on the decision making process of setting prices by Midland Expressway of the price elasticity of demand for tolls being in the range of -0.2 to -0.83. (8 Marks)

PED is less than 0 and greater than 1, so the toll road is inelastic. Producers rise the price by 16.6% and quantity demanded fell by 3.3%. So, the increase in price does not cause the demand of the toll road decrease much, which means total revenue will relatively stay the same.

3. Using elasticity, explain the circumstances under which the decision by Midland Expressway Limited to reduce prices at night time will lead to a rise in their revenue. (6 Marks)

Price elasticity of demand measures the change in quantity demanded of a product in response to a change in the price of the product. Total revenue is the total receipts from sales of a given quantity of the product. For the Midland Expressway Limited to have an increase in revenue when prices for the toll reduce at night, the quantity demanded has to increase. At night time there is a lower chance to have traffic jams and to change to a route, which might be longer but faster due to traffic jams. Having a low possibility of traffic jams and seeing that it is night time and a lot of people often like to be home as soon as possible they will prefer the take the Midland Expressway, which will increase the quantity demanded. So, when the prices of the toll decreases, there would be a more than proportionate increase in demand of the Midland Expressway. This will cause that the PED will be more than 1.

4. What factors could influence the level of the price elasticity of demand for the toll on the new M6 Toll? ( 6 Marks)

There are 3 factors that can influence the level of the PED:

1. The cost of the road. A change in price of the toll road will cause a smaller change in quantity demanded since the product is inelastic, but it will still have relative change in level of PED.

2. The sign of percentage change in quantity demanded.

3. The sign of percentage change in price.

5. If the government decided to increase the tax on fuel such that its price increased by 5%, assess the effect on the use of the toll road assuming that 72,000 vehicles per day use new the motorway and,

therefore, on the prospective revenues of Midland Expressway Limited. ( 12 Marks)

Qd= PED x P Qd= -0.34 x 0.05 Qd = -0.017= -1.7%

Because of petrol and cars are complementary goods, than if Qd of petrol decreases by 1.7%, the Quantity of vehicles will decrease by 1.7% too. So, if the government decided to increase the tax on flue, than instead of 72,000 per day where will be 70,770 vehicles using the motorway per day.

6. Using your knowledge of price elasticity of demand, what might be the reasoning behind the decision by Midland Expressway Limited to run a trial discount period for HGVs? ( 10 Marks)

The quantity demanded of the use of toll by HGVs might have been too low, so the decision to decrease the price of the tall rode for HGVs will increase the quantity demanded. Therefore, the discount period for HGVs is a trail period to gather the information about percentage change of quantity demanded and seeing how much would be possible when there would be a change in price/discount. Also there will be able to see how many damage HGVs will cause on the streets, because they are big and take more space and often make bumps/holes in the street, which takes money to repair, after all this they can figure out how much money is needed from the HGVs to repair street or have enough money for other expenses.