Nora Commentary 1 Final

 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 (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 (PED) explain this yearly phenomenon. As consumers are unresponsive to a change in price of tickets, producers increase price, hence increasing revenue. Approaching fall, the airfares rise by 50% because travelers are inflexible about the itinerary of their flight. Economically, the demand increases and becomes inelastic.

An increase in demand from spring to fall is depicted above. PED (responsiveness of consumers to a change in price) decreases: demand becomes inelastic. “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 also charge an additional $15-$30 per bag. The same increase in price (P₁ to P₂) causes a proportionally smaller decrease (Q_f1 to Q_f2) in quantity demanded in fall than in spring. Thus, when increasing price in fall, the airlines increase revenue. Airlines should not increase their price in spring, because of the elastic demand, causing a shift from Q_s1 to Q_s2, hence a decrease in revenue.

 

Demand for airline tickets is almost perfectly inelastic in the fall because few substitutes exist, and it becomes a necessity to consumers. The airline prices increasing towards the end of the year has occurred similarly for the past 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 shows the inelastic demands for airline tickets of this year and last year. The equilibrium price increases from P_e1 to P_e2. 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 inelastic demand around Christmas, allows the fares to be high (up to 20$ additionally). Last year, airlines had not decreased supply, yet recession was already in force causing a decrease in travelers. This caused a surplus of supply of seats, seen on the diagram, meaning that “airlines used discounting to fill seats”. The seats soon filled because of the law of demand: as the price of a product falls, the quantity demanded of the product will increase.

“Given the upward trend in fares, Grus says book now.” The price of airline tickets is expected to rise until new years. However, the itinerary for which demand is high only concerns a few days around the holiday. A few days before and after, the demand drops, and consumers are more responsive to a change in price (more elastic demand). This forces airlines to decrease their fares so that travelers buy remaining last-minute tickets. For airlines to maximize revenue, providers should 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.

With an economic understanding of how travelers react to the change in price of airline tickets, companies can “out-smart” the recession, and increase revenue even while demand for air travel is decreasing.