Economic Profile of the Airline Industry
Airlines use a formula of combining their yield and inventory costs to determine ticket prices. While it is imperative to focus on the idea of being profitable, the focus is to maximize the cost of the flight revenue. One huge factor that encourages an increase in the cost of tickets relates to a customer ordering a ticket close to the departing date, define this as a risk factor because they need to make up for all unsold seats. A high percentage of the revenue is dedicated to overhead costs such as fuel and labor. When a ticket price is higher with one airline than the other, the customer interprets this as being an excessive cost. The demand is greatly affected by the external market conditions that are in existences such as taxes; by law it is legal to add taxes to airline tickets since they are considered a luxury good (Button, 2005).
The price elasticity of demand in the airlines industry depends on the number competitors that are in that route. For example in a very busy route like New York to LA the price elasticity of demand for the airlines is high, the passengers can switch over from one airline to another (Econ FAQs, 2007). They can substitute the lower cost airlines for the higher cost and so the price elasticity is high. On the other hand non-competitive routes have an inelastic demand. The article quoted below gives the example of the route between Charleston, WV and Atlanta that has a fare of $1,000 (Jerram, 1998).
In general it is difficult to substitute air travel. The other modes of transport like roadways and railways take a relatively longer time to travel. So if a person has to travel he has to use airlines. However, if the there are a number of airlines he can substitute one airlines for another.
Positive and negative externalities
Negative and positive externalities play a vital role in determining supply and demand in the airline industry. Since the airline industry is a direct product of market conditions, it is greatly affected by all externalities. Many people noticed a decline in travel after the September 11th tragedy occurred due to safety concerns. When there is a huge increase in fares that definitely interferes with the demand for travel; it causes the price of tickets to continue to rise since a clear correlation between supply and demand exists. When the economy is doing well in terms of the employment rate, and when the dollar is strong people have the tendency to travel more (Jerram,1998).
In the long run however, if there is persistent low demand, there can be job reductions in the airline industry and even the number of planes can be changed. So there is inelastic price elasticity of supply in the short run. This leads the airlines to reduce rates they charge to passengers when there is a lean season. In the long term the price elasticity of supply is elastic. The long term in this industry is defined as the...