aviation economics - chapter 3

8/19/2019 Aviation Economics - Chapter 3

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Supply and Demand

Analysis in the AirlinIndustry

Chapter 3


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Basics of Demand

•Demand: the ability and willingness to buy specquantities o a good or a service at alternative pa given time period Ceteris Paribus conditions

• !evenue "assenger #iles $!"#s%: are measures or an airline obtained by multiplying the numbe

revenue'paying passengers aboard the aircrat bdistance traveled

• !evenue (on )ilometers $!()%: obtained by multthe weight o paid in tonnage by the total numbe*ilometers it has been transported


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+uantifcation o Demand in the airline industry:

• ,umber o passengers $"A-%

• !evenue "assenger #iles $!"#s%. which normali/es p

demand according to miles traveled• !evenue "assenger )ilometers $!")s%. which normali

passenger demand according to the number o *ilomtraveled0

• !evenue ton miles $!(#s%0

• !evenue ton *ilometers $!()s%

12pressing demand in !"#s gives a sense o airline traterms o distance. and is the preerred metric or airlineanalysis throughout the industry


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(he law o demand

•

(he law o demand states that. ceteris paribus. as price ithe quantity demanded decreases $+uantity demanded hnegative relationship with price%

• Demand Schedule: a table showing the quantities o a gocustomers are willing and able to buy at alternative pricegiven time period. ceteris paribus

•

(he demand curve is downward sloping. confrming the nrelationship between quantity demanded and price

• (he curve is concave to the origin. suggesting that at somdemand increases tremendously as a result o decreasingbut above that point. demand is much less responsive to in price


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• Demand Curve: is a graphical description o the demand schand the quantities o a good that costumers are willing and buy at alternative prices in a given period o time

• Derived demand: demand is derived rom the demand oconsumption or utili/ation o another good or service $(he dor air transportation stems rom actors other than thetransportation itsel%

• Direct demand: demand or goods and services meant or fconsumption

• Demand function: the unctional relationship between quan

demanded and the actors inuencing demand

- Implicit demand unctions simply state general relationshithe quantities demanded and actors a4ecting demand

- 12plicit demand unctions are mathematical relationships quantity demanded and the various variables impacting dem


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• (wo other types o demand unctions are the semunction and the log'linear unction

• 5or the airline industry. it is usually assumed thatypical demand unction ta*es the log'linear sha

• In log'linear unctions the slope o changes


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Determinants o demand or airtransportation•

5actors that a4ect demand: tic*et price0 compettic*et price0 passenger income0 state o the econavailability o other modes o transportation0 pasloyalty0 in'ight amenities0 requency o service0aircrat type. location o airport0 random actors.volcano ash cloud. SA!S. and 7899 or threat o

terrorism

• (ic*et price is the only determinant o demand tcauses movement along the demand curve0 chaother determinants o the demand cause a shit entire demand curve

• "ositive changes shit the demand curve to the r


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• ith the advent o the Internet and numerous praggregation websites li*e 12pedia. (ravelocity. aon. price and competitor6s prices have probably even more important as airline tic*et price inorm

is readily available to potential customers• (he price coe&cient is negative and the cross'p

coe&cient is positive

• (he inverse demand function is also called thunction. and it treats price as a unction o quan

demanded• Consumers with higher incomes are able to purc

more goods and services0 thereore. an increasedisposable income will provide an increase in deor travel

• ;ecause o this direct relationship between dem


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•


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Characteristics o demand or atransportation•

5luctuations0 cyclicality0 seasonality and pea*ing0 directow0 perishability0 schedule wait time0 airport access timtime0 hub connection time0 denied boarding time

• Fluctuations because o the numerous determinants higin the preceding section. demand or individual ights isconstantly changing

•

Cyclicality reers to the long'term trend o pea*s and troeconomic activity

• Seasonality . unli*e cyclicality. which is a long'term cycleis more o a short'term event where demand spi*es $deincreases during the summer > decreases during the wi


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• Directional ow relates to the increased demandpassengers in one direction or a period o time

• (he ma?or problem with cyclicality. pea*ing. and

directional ow is that demand or air transportaperishable (he moment the plane leaves the gaempty seats are lost as revenue'generating prod


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Characteristics o supply or airservice•

Seasonality: Airlines must react to seasonal uctuations in by ad?usting the supply to match the passenger demand Iaccommodate seasonality. airlines need to either pull capae2isting routes. or have idle capacity available to accommoadditional ights $both costly%

• !igidity: airline6s supply is airly rigid as it can be di&cult oto reduce and8or increase supply dramatically Since an air

creates a schedule at least si2 months out. and accepts boto a year out. the airlines must adhere to the schedule or accommodation ees 5i2ed costs. such as investment ininrastructure at hub airports. aircrat leases. and labor conhave to be paid regardless o the schedule. ma*ing it impraairlines to reduce capacity on short'term notice


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Basics of Supply

•

(he perishability o air transport services. the hicosts. and the predetermined capacity in the orschedules that are published well in advance o ight. ma*e supply relatively unresponsive sinceairline cannot shit its supply at short notice


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5actors a4ecting supply o airlinservices•

Supply reers to a frm6s willingness and ability to providspecifc number o seats at a given price. time period. and

• Supply is usually e2pressed in available seat miles $AS#savailable ton miles $A(#s%

• Dividing !"#s by AS# gives us a *ey perormance indicatairlines. the Load Factor

• Load Factor: the percentage o capacity that has been mwith demand

• @oad actors are critical to airline perormance. since theydetermine aircrat utili/ation. derive the proftability o a groute. and indicate the useul utili/ation o capacity


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• The law of supply states that at higher prices produces areand able to produce more products! The "uantity supplied as price increase and decreases as price decrease giveneverything else constant!

•

5actors a4ecting supply are: tic*et price0 price o resource navigation charges0 technology0 availability o other mode transportation0 government regulation0 stochastic actors

• 5or the air transportation industry. production resources inare not limited to. aircrat. uel. maintenance. labor. and laees $a4ect the cost o production%

•

An increase in the cost o production causes a letward shisupply curve

• Deregulation and liberali/ation o air transport have alsosignifcantly a4ected the supply curve Since regulation geprohibits mar*et orces rom determining supply. there is uartifcial cap


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Market Equilibrium

•

At any given price. there will be a quantity demaand a quantity supplied At one price. however. demanded will e2actly equal quantity supplied. apoint is *nown as equilibrium

• It is the point $"% where both supply and demancurves intersect. and price is *nown as the mar*clearing price

• " is achieved through a process o trail and errofrm estimates demand and plans a level o outpcharges a price based on that estimate

•

Due to the perishability o airline service. it is almim ossible to e ual d with s


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Changes in equilibrium

•

Analy/ing changes in equilibrium is straight orwlong as one proceeds by frst deducing which cushiting in which direction


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1quilibrium price ma2imi/esconsumer well'being•

(he equilibrium price is the best possible price consumers given the reality o producer costs Itgenerally optimal or consumers to let price movwherever supply and demand may send it


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"rice Controls

•

It has been argued that the primary ob?ective o control is to prevent e2treme. runaway ination the evils that go with it. but some other negativeconsequences may happen as well

• A controlled price will allocate resources but notaccordance to supply and demand


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Consumer and Producer Sur

•

Consumer surplus is the beneft accrued by conswhose willingness to pay e2ceeds the mar*etequilibrium price (he lower the equilibrium prichigher the consumer surplus

• Consumer surplus is defned as the di4erence bethe total amount that consumers are willing andpay or a good or service and the total amount tactually do pay

• Similarly. producer surplus is defned as the benaccrues to producers whose willingness'to'supplbelow the mar*et equilibrium price


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Airport landing ees and airportcongestion•

12cessive and persistent airport congestion mayunction o a price that is not in equilibrium0 thatlanding ree is *ept too low by government


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"rice oors

•

A price oor is a minimum price. generally abovequilibrium price. set by the government on a pror service

"rice ceiling•


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Disequilibrium

•

(here can e2ist periods o disequilibrium. where does not allocate the quantity demanded and thquantity supplied. even in the absence o governcontrol

• Disequilibria can occur as a result o bothmicroeconomic and macroeconomic shoc*s

• #acroeconomic: 7899 $Aviation system shutdown

• #icroeconomic: ;ad weather conditions $!educecapacity%


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Elasticity

•

1lasticity is a percentage change in the dependevariable $quantity demanded% resulting rom a opercent change in an independent variable $actdemand%

• In measuring elasticity. there are two types o vaendogenous and e2ogenous 1ndogenous variabvariables that the airline can directly control whie2ogenous variables are variables that are out oairline6s control

• (hree ma?or elasticitys: "rice elasticity0 cross'prelasticity0 income elasticity


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"rice elasticity

•

"rice elasticity is the percentage change in the qdemanded resulting rom a on percent change in

• (wo ways to measure price elasticity:

- Point elasticity measures the elasticity o the una specifc value. while arc elasticity measures th

elasticity o the unction at a range o values• 1lasticity can range rom /ero to infnity

aviation economics - chapter 3

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