Case B.

4
Any More Fares?
Pricing on the buses

Imagine that a local bus company is faced with increased costs and fears that it will make a
loss. What should it do?
The most likely response of the company will be to raise its fares. But this may be the
wrong policy, especially if existing services are underutilised. To help it decide what to do, it
commissions a survey to estimate passenger demand at three different fares: the current fare
of 50p per mile, a higher fare of 60p and a lower fare of 40p. The results of the survey are
shown in the first two columns of the following table.

Estimated demand Total revenue Old total cost New total cost
Fare (passenger miles per (£ millions per (£ millions per (£ millions per
(£ per mile) year: millions) year) year) year)
(1) (2) (3) (4) (5)

0.40 6 2.4 1.8 2.2

0.50 4 2.0 1.8 2.2
0.60 3 1.8 1.8 2.2

Demand turns out to be elastic. This is because of the existence of alternative means of
transport. As a result of the elastic demand, total revenue can be increased by reducing the
fare from the current 50p to 40p. Revenue rises from £2m to £2.4m per annum.
But what will happen to the company’s profits? Its profit is the difference between the
total revenue from passengers and its total costs of operating the service. If buses are
currently underutilised, it is likely that the extra passengers can be carried without the need
for extra buses, and hence at no extra cost.
At a fare of 50p, the old profit was £0.2m (£2.0m – £1.8m). After the increase in costs,
a 50p fare now gives a loss of £0.2m (£2.0m – £2.2m).
By raising the fare to 60p, the loss is increased to £0.4m. But by lowering the fare to
40p, a profit of £0.2m can again be made.

Questions
1. Estimate the price elasticity of demand between 40p and 50p and between 50p and 60p.
2. Was the 50p fare the best fare originally?
3. The company considers lowering the fare to 30p, and estimates that demand will be 8 1/2
million passenger miles. It will have to put on extra buses, however. How should it
decide?
Activity: individual or group
The bus company is now considering whether to change the fare and if so, whether it should
go up or down. If it reduces the fare to 30p, it estimates that demand will be 8.5 million
passenger miles. If it increases the fare to 80p, it estimates that demand will be 2.25 million
passenger miles. The company knows it will need to put on extra buses if it cuts the fare and
will need fewer buses if the fare goes up.
How should the bus company decide whether to reduce or increase the fare? Divide yourself
into pairs so that one of you considers the fare reduction and one of you considers the fare
rise. Then discuss your answers and see if you agree on the key things that will determine the
best strategy for the bus company.