Implications for Capital Metro of the Price Elasticity of Demand

Last night on the local (Austin, TX) news, there was a segment concerning how the local public transportation agency (AKA “Capital Metro”) apparently is planning to raise fares. The reporter was speculating about how large of an impact Capital Metro’s pricing decision might have upon ridership. 

Earlier this month, I began teaching a managerial economics course in Baylor University’s Executive MBA program in Austin.  Fortuitously, I just covered the topic of the price elasticity of demand this past week.  This concept measures how sensitive product demand is to price changes for a good or service.  Therefore, I think that my MBA students and I are in a much better position than the reporter was to predict what will likely happen.  Since we know that the price elasticity of demand for public transportation is quite low, averaging around -0.3 in the United States, this statistic implies that the proposed fare increase should reduce overall ridership, but not by nearly as much in percentage terms as the increase in the fare itself. Furthermore, since market demand will decrease in response to an increase in fares, so will overall system costs, assuming that Capital Metro managers not only have the good sense to scale back costs in response to a decline in market demand, but also have the flexibility (particularly from a labor contract and labor relations viewpoint) to do so. The “good” news (from a taxpayer viewpoint, anyway) is that the net effect will be that Capital Metro’s “fare recovery ratio”, or FRR (which measures the percentage of the bus route’s cost that is paid by riders rather than taxpayers) should increase. According to a recent Capital Metro report (see http://bit.ly/2bbGi3), its FRR was just 9% in 2007. Out of 32 North American public transportation systems referenced at http://en.wikipedia.org/wiki/Farebox_recovery_ratio, this is by far and away the worst FRR performance; the average FRR for this group is nearly 40%, and the standard deviation is 18%, which implies that Capital Metro is, in every sense of the term, a true “statistical outlier”.

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