Problem-
Numerous estimates have shown bus transportation to be an inferior good, with an income elasticity of about -0.2. Some years ago, real income dropped about 4% over the year. At this time, the transit authority in a large metropolitan area reduced bus fares by 3% to increase ridership. The result for the year was a 2% increase in ridership, although the system continued to run an operating deficit. Because the bus system perennially had operated "in the red," a consultant was hired to recommend ways of reducing the operating deficit. She claimed that the fare reduction was a mistake and that the operating deficit could be reduced by increasing the fare.
a) Is the consultant correct? Explain why or why not. Show why or why not.
b) If you agree, what is the minimum the fares should be raised, if the only goal of the transit authority is to reduce the operating deficit? If you disagree, provide a rubric for setting the best fare. In either case, be as specific as possible using only the given information.
Additional Information-
The problem belongs to Economics and it discusses the consultant's views on increasing the fare of bus transportation.