The cost of an airline ticket can fluctuate tremendously based on a number of factors. The goal of airlines is to maximize their capacity by having the greatest number of passengers on all trips. This may however be difficult, as airlines pricing is not only dictated by their own operating costs and profit margins required but they have to consider complementary items that could have an effect on supply and demand for their product.
By definition, demand theory explains the inverse relationship between quantity and price. This law explains that if the quantity available of a product or service wanted by the public is low, the price for that product or service will be high. As demand for a product or service increases, the price will increase. This law is critical as we are able to predict prices based on the demand of a product. In the case of airlines, they are able to predict that prices for their services will go up during the high travel months. People are willing to pay more for travel during the summer months, as they know that supply is limited and their available time is defined by their vacation schedules.
If we were to graph this scenario, we would find that price and quantity relationship creates a maximum efficiency point called equilibrium point. The equilibrium point tells us the best combination of price and quantity. With the graph below, we can illustrate that some travelers will be forced to cancel their travel plans due to high ticket costs, just as we can identify travelers that will have to fly no matter what the cost of the fare is. However what economists tend to focus on is trying to find an equilibrium point between price and quantity.
As we know, airlines provide a service to clients by connecting passengers to desired destinations worldwide. Although prices tend to be set by supply and demand, they are also exposed to externalities. An externality occurs when the actions of consumers or producers give rise to positive or negative side effects on other people, who are not part of these actions and whose interests are not taken into consideration. A perfect example of a negative externality is the rise of jet fuel. As a barrel of oil rises, the price of jet fuel also rises and consequently the price of an airline ticket also rises. Externalities can create a positive or negative demand or effect on a product or service.
Price elasticity of demand is a term that helps us understand the measure of the responsiveness of the quantity demanded to changes in price. In general, if there is a large responsiveness of the quantity demanded, the demand is referred to as being elastic, if there is a small responsiveness, demand is inelastic. Airlines take advantage of the existence of inelasticity. Mr. DSouza states in the article, People are still flying. People traditionally plan these breaks, and regardless of the price, they fly.
The demand is very, very high. On the contrary, airlines understand price elasticity and use this well. They know that fare prices can be considered both elastic and inelastic based on the circumstance the traveler finds themselves in. Airlines study their client base, their competitors, and use patterns to predict the behavior of clients based on the condition. They know the probabilities of travelers changing to an alternative airline if their price rises, if they modify their routes, but most of all, they use price elasticity to predict the success of promotions offered by themselves or any other competitor.
Airlines want to lure business by creating special values and convince unplanned tourists to take the trip. Say an average ticket price from Dallas to Las Vegas is $550.00; airlines will create a promotional price and may offer the same route for $199.00. Since the price is so low, people will often forget that they are taking an unplanned trip and will justify the trip by thinking about the cost savings realized and not of the unplanned expense. The demand curve below shows how changes in price lead to changes in the quantity demanded.
Although airline tickets are considered elastic and inelastic, most economists consider it elastic unless travel is done for business use. Domestic airline travel can be substituted by bus transportation, automobile, train etc. Airline travel is elastic especially as the persons income increases so their opportunity for travel increases and they will be more likely to afford the variation in cost.