The total operating revenues of a public transportation authority are $100 milli

Question

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 elesticity 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 perride must the public transportation authority charge to eliminate the deficit if it cannot reduce costs?

Explanation / Answer

a)

elasticity of price is negative ...so percentage change in quantity of demad is smaller than percentage change in price. hence public transportation should increase the price of the ride.

b) let firm increase price by x%

new price = 1 +x

demand = 100 * (1-0.4x)

revenue = (1+x) * (1-0.4x) * 100 = 120

(1-0.004x + 0.01x -0.00004x^2) = 1.2

lets igone the x62 term as it is so small

0.006 * x = 1.2

x= 33.33%

so new price = 1 + x% = 1.33

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