Imagine that a local bus company is faced with increased costs and fears that it will make a loss. What should it do? The most likely response of the company will be to raise its fares. But this may be the wrong policy, especially if existing services are underutilised. To help it decide what to do, it commissions a survey to estimate passenger demand at three different fares: the current fare of 50p per mile, a higher fare of 60p and a lower fare of 40p. The results of the survey are shown in the first two columns of the table.Demand turns out to be elastic. This is because of the existence of alternative means of transport. As a result of the elastic demand, total revenue can be increased by reducing the fare from the current 50p to 40p. Revenue would rise from £2m to £2.4m per annum.But what will happen to the company’s profits? Its profit is the difference between the total revenue from passengers and its total costs of operating the service. If buses are currently underutilised, it is likely that the extra passengers can be carried without the need for extra buses, and hence at no extra cost.At a fare of 50p, the old profit was £0.2m (£2.0m – £1.8m). After the increase in costs, a 50p fare now gives a loss of £0.2m (£2.0m – £2.2m).By raising the fare to 60p, the loss is increased to £0.4m. But by lowering the fare to 40p, a profit of £0.2m can again be made.Questions1. Estimate the price elasticity of demand between 40p and 50p and between 50p and 60p 2. Indicate if the demand is elastic or inelastic in the previous question and how this is interpreted in reality? 3. Was the 50p fare the best fare originally? If not which is the most profitable fare?4. The company considers lowering the fare to 30p, and estimates that demand will be 8.5 million passenger miles. It will have to put on extra buses, however. How should it decide?