Question

The total operating revenues of a public transportation authority are $100 million while its total operating...

The total operating revenues of a public transportation authority are $100 million while its total operating costs are $120 million. The price of a ride is $1, and the price elasticty of demand for public transportation has been estimated to be -0.4. By law, the public transportation authority must take steps to eliminate its operating deficit. (a) What pricing policy should the transportation authority adopt? Why? (b) What price per ride must the public transportation authority charge to eliminate the deficit if it cannot reduce costs?

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Answer #1

Total revenue = $100 million; price of a ride = $1.

Total number of rides = 100 million

Price elasticity = % change in quantity / % change in price.

Price elasticity of demand is inelastic. Increase in price will lead to increase in total revenue.

(a) The price elasticity of demand is -0.4, which is price inelastic. So, the transportation company should think of a hike in the price of per ride in order to eliminate the deficit.

(b) -0.4 = % change in quantity / % change in price.

Percentage change in quantity (rides) = -0.4 x 0.5 (assuming a 50% hike in price)

Percentage change in quantity (rides) = -0.2 or 20% less of demand

Total number of rides = 80,000 rides

New price = $1.50 per ride.

New total revenue = $1.50 x 80,000 = $120,000.

Hence, the public transportation company must charge $1.50 per ride to eliminate the deficit between revenue and costs.

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