Question

The owners of Carciti car park are considering reducing their car parking rates to attract more customers in the hope that the extra customers will increase the revenue they receive from car parking. The current price is $4.00 per day, and 350 car park permits are sold every day. The owners know that reducing the price from $4.00 per day to $3.10 will result in 400 car park permits sold per day.

a) What is the price elasticity of demand for car parks? Include an explanation of what elasticity of demand measures.

b) Will the increase in the number of car park spaces sold per day increase the owners’ total revenue? Explain why or why not with reference to your answer to part (a).

Answer 1

The current price is $4.00 per day, and total permits are 350 per day. At a new price of $3.10 there will be 400 car park permits sold per day.

a) Price elasticity of demand will measure how will the consumers respond to any change in the price by changing their quantity demanded for a good. In this case we use mid point elasticity method to find the value of elasticity

ed = Ed = (Q2 – Q1) / [(Q2 + Q1)/2] / (P2 – P1) / [(P2 + P1)/2]

= (400 - 350)/((350 + 400)/2) divided by (3.10 - 4)/((3.10 + 4)/2)

= -0.526

b) An increase in the number of car park spaces sold per day is likely to decrease the owners’ total revenue. As you can see, the revenues fall from 4 x 350 = $1500 to 3.10 x 400 = $1240. This is true because elasticity is value is less than 1 in absolute terms suggesting that demand is inelastic. When demand is inelastic, any price reduction causes revenue to fall.