Suppose you are a transportation planner working for a large city. You are charged with implementing a new bus system that reduces emissions of particulates by 50%. This is predicted to improve urban air quality from a level that is judged unsafe for "vulnerable populations" to a level that is deemed safe for daily exposure (using best available information).
To fund this system, the city is considering raising bus fares from $1.00 to $1.50 a trip for all passengers. For simplicity, consider two groups of people - urbanites and suburbanites. This city has not seen extensive gentrification of its inner city and so urban residents are typically poorer and more dependent on public transit compared to relatively affluent suburban residents. However, the predominant pattern is for both groups to predominately work in the city center. The total monthly demand curve of each group for trips on the bus system is P=10-.0001*q for urbanites and P=20-.00008*q for suburbanites.
a. Notice that both urbanites' and suburbanites' demand functions have a "choke price", a price above which zero trips are taken. How can you explain this in light of the fact that transportation is essential for individuals to conduct their lives (to get to work, etc.)? (Hint: think about the price and availability of substitutes.) Can you list factors that may affect the shape of the demand curves?
b. Calculate the monthly consumer surplus for each group before and after the rate increase. Your boss wants a measure of the losses to each group from the rate increase. Obtain these measures from your previous calculations (this should be simple) and explain their meaning.
c. Suppose you are tasked with making decisions based on economic efficiency. What is the minimal magnitude of benefits that must be generated to suburban and urban residents in total from the improved air quality in order to justify the new system as an improvement relative to the status quo (assuming no spillover benefits beyond these groups exist)?
d. Assume the benefits to pollution reduction exceed the threshold you've found in part c. Does it follow that both suburban and urban residents are made better off by the policy change (i.e. was it a Pareto improvement - a "win-win")? How do the scientific details of the "fate and transport" of the reduced pollution (i.e. the spatial footprint of pollution reductions) matter for answering this question?
e. The transit authority is concerned about the effects of the policy on total monthly ridership and fare revenues. Use the demand curves for each group to calculate the percentage reductions in ridership and fare revenues from the fare increases for each group.