Louie- Louie Case

Deepak (Louie) Jain, the general manger of the Delly Transit Authority, drummed his
fingers on his desk. Projected revenues were 67.45 million monetary units below
projected costs for next year. The Central government has indicated that no financial help
will be forthcoming. The State government has indicated that somewhere in the
neighborhood of 20 million monetary units might be authorized, but the legislature was
concerned that they would be shipping money to a bottomless pit with no end to such a
subsidy. Even if the money from the State materialized, Louie would still be 47.45
million monetary units short---well assume hereafter that the money from the state will
occur.

In reality, Delly and its surroundings are an economic engine that contributes much to the
State and the transit system enables increased productivity to the employers in the city
(enabling their employees to get to work easily and less stressed than if they traveled by
private vehicle) and decreases the number of private vehicles on the already vastly
overcrowded road system (hence decreasing congestion and pollution).

A recent research publication from ISB lies on Louies coffee table. Louie picks it up and
absent-mindedly thumbs trough it as his mind races through the possibilities to balance
his budget.

Suddenly, an article co-authored by an ISB faculty member and a member of the State
Ministry of Transport catches his eye: The Journey to Work in the Delly Metropolitan
Area. As he studies the article, he notes the following table:

Short Run Own Fare Elasticity Long Run Own Fare Elasticity
-0.3 -1.1

Louie knows that his current daily ridership is 0.8 million riders at the current fare level
of 1.5 monetary units per ride. He feels that a linear approximation of the demand curve
for Delly Transit services would not be unreasonable. In the short run, most costs would
be fixed, i.e., not vary with ridership, but any costs which are variable with ridership
would change only slightly as ridership changed. He feels that the same number of busses
and trains would run under a modest fare change and thus that the variable costs of
operation are so trivial that they can be ignored. Thus, if his budget problems are to be
solved, the solution must come from the revenue side. The costs effects of a ridership
change will, therefore, be ignored in the analysis below.

Louie picks up his hot phone line and within moments his assistant Parva Gupta, Louies
right hand person, is in the room. Parva, what does this ISB study tell us about the
demand for our services and can we use the information in there to help us balance our
budget?
Question 1: Help Parva out. What is the linear short run daily demand curve for
transit given the ISB articles information and the current fare and ridership level
of Delly Transit?

Question 2: What short run strategy (in general and specifically) would you come
up with given this demand curve and the pending budget needs of Delly Transit?
(Assume the state comes up with its 20 million monetary units and assume that each of
the years 365 days has the same demand curve). Generally means the direction the fare
should go and specifically means the magnitude of the fare change.

Question 3: Will the same type of strategy work in the long run? Specifically tell
why or why not? What should Louie do in the long run (assume no new investment or
disinvestment is needed and that you can ignore the slight changes in cost associated with
changes in ridership)?

Question 4: What are some of the likely reasons for this difference in elasticities
between the long run and the short run?

Upon further investigation, Parva finds that ISB and the Transport Ministry have done a
more advanced study that gives an elasticity relationship with respect to Delly Transit
travel time. The results are shown in the table below.

Short Run Travel Time Elasticity Long Run Travel Time Elasticity
-0.7 -1.6

Parva knows that it costs the same amount to institute a 1% increase in the fare (new
settings for the fare machines, etc.) as it would cost to bring about a 1% lowering of the
transit times (by speeding up vehicles, etc.).

Question 5: If you could only do one of the above in the short run (raise fares by 1%
or lower travel time by 1%), what would you do? Why?

The more advanced study also indicates that urban/suburban differences exist in the
above fare and time elasticities. The suburbanites have more elastic fare elasticities and
more elastic travel time elasticities than the urbanites. In addition, the income elasticity of
demand for transit is negative for the whole Delly Metropolitan region.

Question 6: Why do the fare and travel time elasticities differ between the suburbs
and the city?

Question 7: What does the income elasticity tell you?

Question 8: Develop a strategy (longer term) to counteract any negative impacts to

transit that you uncovered in your elasticity discussions of this case.