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Parking Garages & Price Elasticity

One of the saddest days in my short time as an MBA student happened in January 2011 when the local parking garage increased their Loyola discounted rate from $6 to $8.  I didn’t even see it coming!  Suddenly, the price of my only means to get to school increased 33% (driving to school twice per week after work can add up).  After shopping around a bit, I reluctantly accepted my fate and continued on with my normal routine, I had no choice.  And then, everything changed on March 1, 2012.

I noticed last Thursday night that the parking rate has suddenly dropped back down to $6!  At first I thought I had seen a ghost, a phantom of past parking.  However, after my class Saturday morning, I confirmed that what I saw was actually real, $6 parking had returned.  I thought to myself “this could never happen” because, as many of you may know, the street meter rates have been sky-rocketing over the past few years.  I couldn’t understand why the discounted parking rate would ever decrease their parking.  Then I remembered the Price Elasticity of Demand.

Imagine you own the parking garage and you get this crazy idea that you should raise the price from $6 to $8 to increase revenue.  You want to increase revenue because all of your costs are fixed.  You have already paid for the parking garage and have upgraded the pay machines to fully automate the customers.  The only people you have employed are the security guards and one office person to help count all the money you are making.  Raising the price will raise revenues and more profit will follow.  It’s a win-win!

Your price increase has gone through, so what happened?  You typically have 12 people from Loyola who park in the garage per day at the discounted rate.  Currently you are earning $72 per day with the old $6 rate.  Your fixed costs are $70 per day (the parking garage business is tough with thin margins!).  The price increase takes affect and you notice that demand has fallen off a little bit to 10 people per day.  The new revenue is $80 per day with a new profit of $10 per day, a 500% increase!  That’s amazing!  Raising our price went so well, we should do this every day…but wait.

Now demand has slowly fallen due to the price increase.  The number of people from Loyola parking in your garage has dropped to 8 people per day.  The revenue has dropped to $64 per day while our fixed costs remain at $70.  Now we are operating at a loss of ($6) per day!  If we keep this up, we’ll be out of business soon.

So what do you do?  You decide to hire a brilliant MBA student from Loyola to help you understand what went wrong.  The first thing the student tells you about is the Price Elasticity of Demand and how your customers reacted to the price increase.  The change in demand was much greater than the change in price.  The brilliant MBA student suggests the best route would be to lower the price to increase demand and get the garage profitable again.

Who knows what will happen next, maybe some blogger will notice and give you some free advertising to one of your target markets…

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