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    Calculate the Optimal Pricing Strategy using Price Elasticity

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    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 elasticity of demand for public transportation has been estimated at -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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    Solution Preview

    Price elasticity of demand is the mathematical relationship between a change in price and a change in quantity demanded. The formula is:

    Ed = (Q2 - Q1)/Q1 / (P2 - P1)/P1

    In this example, Ed = -0.4, P1 = 1 and Q1 = 100 million.

    a) Ed is between 0 and -1, which means that at the current price, public transportation is price inelastic. The public transportation authority can increase ...

    Solution Summary

    This solution shows how to use price elasticity of demand to calculate the public transportation authority's optimal pricing strategy to eliminate its operating deficit. All formulas and calculations are given.