Analyse how an airline operator could estimate the elasticity of demand for it’s services.

Evaluate the significance of this knowledge for the firm in making it’s pricing decisions to maximize it’s revenue when operating in the highly competitive NZ airline industry

In your answer:(i) Analyse how an airline operator can benefit from knowledge of each of

the three elasticities of demand when making it’s pricing decisions.(ii) Discuss the factors that might help an airline operator determine the level

of elasticity of demand for it’s services (ie PED, XED, YED)(iii) Evaluate the importance of this knowledge to an airline operator in

maximizing it’s revenue in the long run.

Airline operators can benefit from knowledge of each of the elasticities; Price, Income and Cross elasticity of demand. Firstly, Price elasticity of demand measures the responsiveness in quantity demanded when there is a change in price. The price elasticity of demand is beneficial to airline operators as it demonstrates either elastic or inelastic demand. Inelastic demand means there is little response to demand of air travel when there is a change in price resulting in a coefficient less than 1, whereas elastic demand has a big proportionate change in demand for air travel when there is a change in price, resulting in a coefficient greater than 1. For example, in resource A, it shows elastic demand for leisure travellers with price elasticity of demand coefficients of 1.1 and 1.4 while business travellers demonstrated inelastic demand with coefficients of 0.8 and 0.2. The elasticity shows a direct correlation between the purpose of travel. Leisure travellers demonstrate elastic demand because it’s not a necessity for them to travel around a particular week or day, so they can easily change plans and day of travel. Therefore, they are very responsive to changes in the price of air travel. On the other hand, business travellers demonstrate inelastic demand to air travel, because it is necessary for them to travel within a certain time period, because it is necessary for them to do so. As a result, they have little response to changes in the price of air travel. This is very beneficial to airline companies to maximize their revenue in the long run, as they can use price discrimination on air travellers, based on whether their demand is elastic or inelastic. As explained by resource E, Price discrimination is the “action of selling the same product at different prices to different buyers, in order to maximize sales and profits”. For example, in Resource C, we can see that air travel firms can discriminate based on “identity of the traveller, destination, time of departure and time of return.” The knowledge of these help air travellers to accurately discriminate air travellers to help them maximize their profits in the long run.

Winnie

Income elasticity of demand measures the responsiveness in quantity demanded when there is a change in consumer income. For example, if housing prices rise, consumer confidence of air travellers is increased as they feel more wealthy, and therefore are willing to dispose of their extra income on luxuries such as air travel. Another example is airline companies can gather information from the economy such as inflation- a general increase in the price level of goods and services of an economy. As inflation decreases, consumers feel as though they have more disposable income that they are willing to use. Airline companies can also calculate the coefficents for the income elasticity of supply where coefficients less than one demonstrate inelastic demand, and coefficients greater than 1 demonstrate elastic demand, as earlier mentioned before. With these elasticities, they’re also able to use price discrimination. From resource D we can see that firms are able to use this information depending on the time throughout the year to charge extra money to maximize total revenue with extra “bag charges…meals on flights…priority screening, early boarding”. For example, charging extra prices for priority boarding, meals on board and air travel ticket prices during a period of economic boom- a period of rapid economic expansion resulting in higher GDP, lower unemployment and rising asset prices. Airline companies benefit from the knowledge of income elasticity of supply, because depending on the state of the economy during a certain period, they are able to make strategic price decisions to maximize total revenue.

Cross elasticity of demand measures the responsiveness of the quantity demanded of good X, when there is a change of price in Good Y. Good X and Y must be related, such that they are either complements or substitutes. In this case, we look at the effect on one airline, when another airline company changes their prices. Airline operators can benefit from the knowledge of cross elasticity of supply, because based on this, they can construct which method of Pricing Competition to use towards other companies, in order to maximize total revenue for their own. For example, from resource G, we see that based on cross elasticity of supply, Jet Star has chosen to challenge competitors in the same industry through a price war- in which they cut prices in an attempt to increase their share of the market. In this example, “Jetstar offers one cent flights” to “battle to be the cheapest airline”. From the resource we are able to see that Air New Zealand suffered greatly from the price war of the Australian company Jetstar, so in order to counter this, they too engaged in price war, offering tickets as cheap as “$7 each way”. Here, price war has helped Air New Zealand to choose a price that brings back their share of customers. Other factors that might help an airline operator determine the level of elasticity of demand for it’s services can be determined by their loss of customers.

Overall, we are able to see the importance of knowledge each of the three elasticities, Price, Income and Cross elasticity of demand. Through these, we are able to identify factors that help an airline operator determine the level of elasticity of demand for it’s services. Knowledge of these influencing factors are able to help airline firms develop informed strategies in maximizing their revue in the long run.