Holiday airfares close to last year but climbing
Many complain about the high prices of airplane tickets as holiday season approaches. Why is this? The concept of demand, which is the quantity of a good or service that consumers are willing and able to purchase at a given price in a given time period, price equilibrium, and price elasticity of demand explain this phenomenon. As consumers become less responsive to a change in price of a product producers increase price but maintain the quantity demanded, hence increasing profit. The price of airline tickets differs depending on when in the year they were purchased. Approaching fall, the prices of airfare tickets rise by 50% because travelers are less flexible about their destination and the date of their flight. The earlier the tickets are purchased, the less consumers are willing to pay for the same ticket. Economically, the demand for airline tickets increases and becomes inelastic as Christmas approaches.
The diagram above shows the increase in demand (positive shift of demand curve) from spring to fall. The price elasticity of demand (PED), which measures the responsiveness of consumers to a change in price, decreases, meaning demand becomes more inelastic. Consumers are less responsive to a change in price of airline tickets in fall than in spring. "For the holidays, the big airlines added a $20 surcharge each way on popular travel days closest to Christmas and New Year's. Furthermore, "several [fares] had risen 50% or more".
Airlines could also charge an additional $15-$30 per bag. The increase in price of airline tickets in fall (from Pef to P2) causes a proportionally smaller decrease in quantity demanded. Thus, the airlines increase revenue. On the other hand, an increase in price of the same amount in spring (from Pes to P1) causes the quantity demanded to decrease by a larger percentage.. Airlines should not increase their price in spring because of the elastic demand, which would cause a decrease in revenue.
The PED of airline tickets becomes less elastic as Christmas approaches because few substitutes exist to travel quickly to family and friends, and because travelling shortly before Christmas becomes more of a necessity to consumers. Although the air travel market is an oligopoly (a market with a few large producers), all airlines are aware of the inelasticity of demand as holiday season approaches, and therefore the price of all airline tickets increases.
The airline prices increasing towards the end of the year has occurred similarly for the last few years. However, the economic recession impacts the air travel market. "Airlines have been shrinking to match a decrease in travel. With the supply of seats more in line with demand, carriers have been able to raise fares close to where they were last holiday season." The decrease in travel is shown by a decrease in demand (a shift of the demand curve to the left). A decrease in income or the expectation of a decrease in income causes consumers to travel less (decrease in demand). Compared to last year, the airlines decreased supply to avoid surplus, shifting the supply curve to the left.
The diagram above shows the inelastic demands for airline tickets of this year and last year. The equilibrium price increases from Pe1 to Pe2. The equilibrium price is where demand and supply intersect, with no surplus or shortage of seats. If the airlines would not have decreased their supply in response to the decrease in demand, there would be a surplus of seats (diagram below) and the average fares could not have been increased without the airlines losing revenue.
The decreased supply and the fact that demand is so highly inelastic around Christmas, allows the fares to be relatively high (up to 20$ additionally). Last year, airlines had not decreased supply, yet recession was already in full force and the amount of travelers had decreased. This caused a surplus of supply of seats, meaning that "airlines used discounting to fill seats".
The seats soon filled because of the law of demand that states that as the price of a product falls, the quantity demanded of the product will usually increase.
"Given the upward trend in fares, Grus says book now."
The expectations are that the price of airline tickets will keep on rising until new years. However, the demand for plane tickets is only so high for a few days before and after the holiday. A few days before and after, the demand drops, and consumers are more responsive to a change in price (demand is more elastic). This forces airlines to decrease their fares so that travelers buy remaining last-minute tickets. For airlines to maximize revenue, providers should on one hand increase price when demand is highly inelastic, as quantity demanded will not drop by a significant amount. On the other hand, airlines need to reduce supply of airplanes for the days that are off the mainstream itinerary. This would make supply level with demand, and airlines would not have to decrease their price to fill seats, therefore maximizing revenue.
