Economic Profile: Airline Industry

Economic Profile: Airline Industry

Introduction

The airline industry provides services for passenger and cargo transport. Over the years the airline industry has faired fairly decent. That is, until the September 11 tragedy in 2001. From 1995 through 2000, the airline industry earned about $23 billion then lost about $35 billion from 2001 through 2005 (McCabe, R., 2008). There are many factors that indicate the economic downfall of the airline industry after the September 11 incident. The purpose of this paper is to discuss some of these factors and their impact the airline industry. Issues for discussion include: (1) shifts and price elasticity of supply and demand, (2) positive and negative externalities, (3) wage inequality, and (4) monetary and fiscal policies. The final discussion (final thoughts) will include how the economy affects the success of the airline industry and economic influences that can affect the airline industry in a negative way.

Shifts and Price Elasticity of Supply and Demand

Profits and losses in any industry are determined by the shifts of supply and demand. When there is a decrease in labor supply the equilibrium wage rate will increase and the equilibrium quantity of labor hours will decrease. In turn the wage rate increase will lower the demand for labor supply. As worker wage rates are increased employees are willing to work longer hours which increases the marginal utility. If employee wages were to be considerably increased to an outrageous extreme the result would be a diminishing marginal utility. “In other words, as a person’s income rises, the extra wellbeing derived from an additional dollar of income falls” (Mankiw, N. G., 2004). Correspondingly, when there is an increase in labor supply, the equilibrium wage rate will decrease and the equilibrium quantity of labor hours will increase. In turn the wage rate decrease will increase the demand for labor supply.

The decrease in labor supply after September 11 wreaked havoc on the airline industry. Prior to the September 11 terrorist attacks most airlines were at a financial peak. Since September 11 airlines have suffered financial crisis. Many airlines have gone bankrupt due to the economic depression, lower ticket prices and increased oil prices that have occurred since September 11. This financial crisis has caused a shift in airline business procedures toward customer service and satisfaction above all else. Airlines now consider customer purchasing patterns and buying history in order to determine elasticity demand of services (Haewoon, Y., 2007).

The two forms of air travel used to determine airline demand elasticity are regular and standby air travel options. A study was performed through a local airline with a consistent commuter market. Although regular reservations have the advantage of a guaranteed flight, locals were more inclined to opt for standby status to be able to save money on the flight (Animesh, G., 1981). Price changes i.e. standby status etc. seemed to be more elastic than permanent price change, but both are elastic. Fortunately, standby travel options are provided for certain flights as a suitable substitute. Since seating is determined by destination all airlines may be able to provide a seat for the same destination with varying prices. Since airlines are competitive customers are able to compare prices and find the most affordable flight that will fit within their budget. However, what is good for the consumer may not be so good for the airline industry.

The price elasticity for airlines is inconsistent due to the competitive market. For instance: two airlines may offer seats for a flight in rout to the same destination; if one of those airlines initiates a price-cut the competitor will follow suit and lower their price as well. If the competitor declines to lower the price of their seat customers may shift their interest (business) to the lower price airline. Therefore, price elasticity in the airline industry is very high and considerably sensitive because most airlines are more apt to change their prices in response to competitors with similar services at lower prices to maintain customer associations.

Positive and Negative Externalities

An externality can be defined as the impact that one persons’ decision has on another person. Externalities may be determined as positive or negative depending on the outcome of the impact they have on an individual or a group of people. In the airline industry transaction of a buyer and seller directly affect a third party both positively and negatively. Banks and credit card companies could be affected positively through interest rates charged to card holders for the transaction. However, there could be a negative affect if card holders do not pay their bill i.e. loss of funds, incurred legal expenses and so forth. Additionally, third parties are affected negatively by air pollution, greenhouse emissions, carbon emissions and environmental taxation. Positive externalities include government intervention to reduce market failure from negative externalities, counter terrorism measures, public safety, generation of tourism, and lowered pollution levels.

In an attempt to reduce market failure from negative externalities for airlines through price mechanism intervention and command and control measures the UK and Europe have come up with several strategies. Government policies have been designed to attain more efficient use of resources, endorse substitution between scarce and non-renewable resources, and offer to decrease pollution emissions. According to Riley, G. (2006) some of these strategies and issues include but are not limited to.

• External taxation: deemed detrimental to the environment in the areas of increased private cost to producer and consumer of negative externalities to promote distributive efficiency, incentive to take externalities into account, raised prices lower consumption and pollution levels, reduce production output levels to provide a more stable economy, encourage innovation and the development of new technology, provide source of revenue for government spending while correcting externality issues, improve present environmental costs to ensure intergenerational equality. Examples: petrol duty, carbon tax etc.

• Carbon emissions trading: involves trading of greenhouse gas emission rights between nations i.e. when a country exceeds greenhouse emissions that country can pay another country for the right to use surplus gas emission rights.

• A carbon allowance for consumers: involves charging consumers for the amount of personal carbon usage. Consumers will carry cards with allocated

...