The total operating revenues of a public transportation authority are $100M while its total operatiing costs are $120M. The price per ride is $1, and the price elasticity of demand for transportation ia -0.4. The transportation authority has to eliminate its operating deficit.
(a)What pricing policy should the transportation authority adopt? Why?
To determine the pricing policy that the transportation authority should adopt, we need to consider the elasticity of demand and the current operating deficit.
The elasticity of demand measures the responsiveness of demand to changes in price. A price elasticity of demand of -0.4 means that a 1% increase in price will result in a 0.4% decrease in demand.
Given that the transportation authority is facing an operating deficit, it needs to increase its total operating revenues. To do so, it can either increase the price per ride or increase the number of rides. However, we need to consider the price elasticity of demand in order to make an informed decision.
Since the price elasticity of demand is greater than 1 (-0.4), it indicates that demand is relatively elastic. This means that customers are more responsive to price changes, and a price increase will result in a proportionally larger decrease in the number of rides.
In this scenario, increasing the price per ride would not be a feasible strategy to eliminate the operating deficit. The decrease in demand due to the higher price would likely result in an even greater revenue loss, leading to a larger operating deficit.
Instead, the transportation authority should adopt a pricing policy that focuses on increasing the number of rides. This can be achieved by reducing the price per ride. The decrease in price would make transportation more affordable and attract more customers, resulting in a larger number of rides. The increase in demand would generate higher total operating revenues, helping to eliminate the operating deficit over time.
In summary, the transportation authority should adopt a pricing policy that reduces the price per ride to increase the number of rides and generate higher operating revenues.