Leopold Bus Company runs daily service between Bigcity and Tinytown. It calculat
ID: 1168197 • Letter: L
Question
Leopold Bus Company runs daily service between Bigcity and Tinytown. It calculates that the average cost per trip (wages, gas, insurance, payments on loans, etc.) is $140. Leopold sells the bus tickets for $5 each. The busses hold 40 people, but are usually just three-quarters full. Leopold is considering half-rate tickets to students, on a standby basis.
Will the sales of the standby tickets cover the average costs of the extra passengers?
Will the sales of the standby tickets cover the marginal costs of the extra passengers?
Should Leopold proceed with the plan? Why?
Can you think of circumstances under which it would be unwise to offer the standby choice?
Explanation / Answer
The companies cost per trip is $140. The company is currently selling 30 tickets (75% of 40) at $5 each. Company’s revenue is $150 (=30 × $5). Therefore the company is already making a profit of $10 (=$150 - $140).
The bus has unused capacity of 10 more passengers. Filling that unused capacity won’t cost the company anything. Therefore, there are no marginal costs of extra passengers.
This means that the company can sell the standby tickets at any price and the marginal costs will be covered (because they do not exist).
Since there are no marginal costs, the average costs are also not there. This means that the company can sell the standby tickets at any price and the average costs will also be covered (as they also do not exist).
The plan of filing the unused capacity through the use of standby tickets will increase profits as the sale of standby tickets will increase revenue without increasing the cost. Therefore, the company should totally proceed with the plan.
It would be unwise to offer standby tickets if filling the unused capacity meant that costs would increase more than the revenue.
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