Question

A city has built a bridge over a river and it decided to charge a toll to everyone who crosses. For one year, the city charges a variety of different tolls and records information on how many driver cross the bridge.The city thus gather information about the elasticity of demand. if the city wishes to raise as much revenue as possible from the tolls, where will the city decide to charge a toll: in the inelastic portion of the demand curve, the elastic portion of the demand curve, or the unit elastic portion? explain​

Answer 1

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Answer 2

Concept:

Elasticity of demand can be defined as the ratio of the percentage change in quantity demanded of a good to the percentage change in its price level.

The elasticity of demand is negative because there is an inverse relation between the quantity demanded and the price of the good. This means, when the price rises quantity demanded decreases. And when the price decreases, quantity demanded increases.

Given:

A bridge has been built over a river in the city and a toll tax is charged. Information about demand elasticity is gathered by charging a variety of different tolls on drivers crossing the bridge.

To find:

The point on demand curve where toll will be charged in order to earn maximum revenue.

Solution:

Revenue earned is calculated by multiplying the quantity will the price level.

• In the given problem, number of cars crossing the bridge is the quantity.
• The toll tax charged is the price/revenue earned per car.
• The total revenue is total cars multiplied by the tax charged per car.

Elasticity of demand curve tells us how will the number of cars crossing the bridge change with the change in toll tax charged.

• If the demand is inelastic, the number of cars crossing the bridge does not change drastically with change in toll tax.
• If the demand is unitary elastic, the change in number of cars will be in equal proportion to change in taxes.
• If demand is elastic, the number of cars crossing the bridge change with change in toll tax.

In order to maximise revenue, We will charge toll tax on the inelastic portion of demand so that with increase in taxes the number of cars does not change and we can earn more.

Hence, the tax should be charged on the inelastic portion of demand curve.

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