Assessment task 1
1. SteamScot face a ‘basic economic problem’ what is this ‘problem’ and what is the opportunity cost of the replace and repair programme?
The basic economic problem refers to a situation where human wants are unlimited while human resources are finite; it is the economic problem of scarcity of resources. At any one particular time, the resources of the earth are capable of producing a limited number of goods and services, however, human wants exceed limited production possibilities and this gives rise to what is known as the economic problem of scarcity.
In the passage ,Steam Scot have a budget of £2.5 million and this can be spent on adding a new route are ...view middle of the document...
60,000 passenger units
3. Calculate, using total revenue, the price elasticity of demand when:
(i) price rises from £4 to £5
(ii) price falls from £4 to £3
I. Elasticity is a measure of the responsiveness of demand to changes in the price of a good or service. In the case of Steam Scot, when the price rises from 4 to 5, demand falls from 60,000 to 40,000 units. The original equilibrium market price of 4 pounds resulted in demand of 60,000 units and this generated revenue of 240,000 pounds. When the prices increased to 5 pounds the resulting demand is 40,000 units, and this generates total revenue of 200,000 pounds. When market price changes from 4 pounds to 5 pounds 40,000 pounds of revenue are lost in this indicates an elastic price elasticity of demand.
II. When price falls from 4 pounds to 3 pounds the demand for travel increases to 80,000 units- At the original market price of 4 pounds the demand for travel was 60,000 units generating revenue of 240,000 pounds. When the price is reduced to 3 pounds the resulting demand is 80,000 units and this also generates income of 240,000 pounds. When market price changes and the resulting revenue remains the same it can be said that price elasticity of demand is unitary in value.
3 b- If you were a member of the SteamScot board, what would you recommend the company does in both situations? Give reasons for your advice.
In the first situation the price increased from 4 pounds to 5 pounds and demand fell from 60,000 to 40,000 units resulting in a loss of revenue of 40,000 pounds. According to the profit maximizing principle, a firm should pursue a course of action that generates the greatest profit and this is indicated by not changing the price. There is no information given about the result of the drop in passenger travel on the cost structure of Steam Scot and in the absence of this information it would appear that the best course of action would not be to raise the price as it results in falling revenue which is contrary to the principles of profit maximization.
In the second situation, dropping the market price from 4 pounds of 3 pounds would result in extra traffic of 20,000 units; however, this is without an increase in revenue as elasticity of demand appears to be unitary. There is no clear-cut recommendation in this case as there are advantages and disadvantages to dropping market price. In terms of advantages, dropping the market price will attract more traffic and these extra passengers may spend more money on associated goods and services that would benefit the railway. The railway may also be in a better position to promote its services because of the increase in traffic that would benefit its reputation and image in the marketplace.
On the other hand, the increased traffic would...