The local community bus service, which is a monopoly, charges $2.00 for a one-wa

Question

The local community bus service, which is a monopoly, charges $2.00 for a one-way fare. The city council is thinking of raising the fare to $2.50 but expects it to generate less than 25% more revenue. The council has asked for your advice as a student of economics. The council predicts that raising the price by 25% will raise revenues by less than 25%. Which of the following is true? Choose one: A. The council hasn't taken into account either the output effect or the price effect. B. The council has taken into account the price effect but not the output effect. C. The council has taken into account both the price effect and the output effect. D. The council has taken into account the output effect but not the price effect. Part 2 (1 point) Therefore, the council has increase in revenue.

Explanation / Answer

An x% increase in the price of a good increases the total revenue by less than x%, because total revenue is the product of price and output, and a rise in the price causes a fall in output due to law of demand. The fact is that a given percentage increase in price of a good may even decrease total revenue if the decrease in output is substance. Therefore, the council has taken into account both the price effect and the quantity effect, and Option C is correct.

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