Industry Research

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Economic Profile of the Airline Industry Axia College of University of Phoenix

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Shifts and price elasticity of supply and demand Airlines use a formula of combining their yield and inventory costs to determine ticket prices. While it is imperative to focus on the idea of being profitable, the focus is to maximize the cost of the flight revenue. One huge factor that encourages an increase in the cost of tickets relates to a customer ordering a ticket close to the departing date, define this as a risk factor because they need to make up for all unsold seats. A high percentage of the revenue is dedicated to overhead costs such as fuel and labor. When a ticket price is higher with one airline than the other, the customer interprets this as being an excessive cost. The demand is greatly affected by the external market conditions that are in existences such as taxes; by law it is legal to add taxes to airline tickets since they are considered a luxury good (Button, 2005). The price elasticity of demand in the airlines industry depends on the number competitors that are in that route. For example in a very busy route like New York to LA the price elasticity of demand for the airlines is high, the passengers can switch over from one airline to another (Econ FAQs, 2007). They can substitute the lower cost airlines for the higher cost and so the price elasticity is high. On the other hand non-competitive routes have an inelastic demand. The article quoted below gives the example of the route between Charleston, WV and Atlanta that has a fare of $1,000 (Jerram, 1998). In general it is difficult to substitute air travel. The other modes of transport like roadways and railways take a relatively longer time to travel. So if a person has to travel he has to use airlines. However, if the there are a number of airlines he can substitute one airlines for another.

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Positive

and

negative

externalities

Negative and positive externalities play a vital role in determining supply and demand in the airline industry. Since the airline industry is a direct product of market conditions, it is greatly affected by all externalities. Many people noticed a decline in travel after the September 11th tragedy occurred due to safety concerns. When there is a huge increase in fares that definitely interferes with the demand for travel; it causes the price of tickets to continue to rise since a clear correlation between supply and demand exists. When the economy is doing well in terms of the employment rate, and when the dollar

is

strong

people

have

the

tendency

to

travel

more

(Jerram,1998).

In the long run however, if there is persistent low demand, there can be job reductions in the airline industry and even the number of planes can be changed. So there is inelastic price elasticity of supply in the short run. This leads the airlines to reduce rates they charge to passengers when there is a lean season. In the long term the price elasticity of supply is elastic. The long term in this industry is defined as the time taken to reduce the

fleet

of

planes

and

the

time

taken

to

re

structure

the

workforce.

The airline industry is interpreted as being very unstable due to the immediate reaction to tragedies. The airline industry was affected following the September 11 th tragedy and it affected other industries indirectly. The airline industry plays a key role in globalizing our economy and the market is strongly dependant on the airline industry. The rise and decline in fuel costs is another negative externality that affects the airline industry. Fuel costs have been on the rise for quite sometime, so customers have gotten used to the change (Jerram, 1998).

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An airport is a non-rivalrous, excludable resource. It is therefore a public good rather than a common pool resource. Once an airport is built, its use by one person doesn't make it less valuable for others, so it is non-rivalrous. But people can be excluded from it if they are unable to purchase tickets. The transaction between the airlines and the passengers affects those who live in the vicinity of the airport through pollution. Air traffic congestion is a negative externality that impacts other passengers. I found two articles regarding the externalities of airports. Negative and positive externalities play a vital role in determining supply and demand in the airline industry. In many cases external costs can affect the lifespan of many airlines. The airlines are dependant on customers to buy their tickets in order to survive the external cost of fuel, labor, and advertising. The external costs are set depending on the current condition of the market. According to Riley, G. (2006), over the last 20 years airlines such as PanAm, Texas Air, and TWA have gone out of business. Externalities such as tragedies (in some cases crashes) as well as over-head costs left these airlines in turmoil. Two notable airlines United and Delta went bankrupt, but they managed to climb out by making changes. Delta and United escaped bankruptcy by cutting back on employee pay, pension plans, and in-flight meal service. The rate of transaction affects the livelihood of current employees, retirees, customers, and each individual airline (USA Today, 2005). There is no clear classification of the airline industry because it serves a broad purpose. If a customer is flying for business purposes overseas, there is no easy alternative. The classification would be based on the customer's purpose of travel. People who are flying for pleasure are not being forced, so leisure travel would be considered

5 excludable. There are clear seating capacities on airplanes; it would rival which would classify the airline industry as a public good. When someone is forced to travel for business purposes, the travel would be considered non-excludable. It would be difficult to determine if a rival exists since there are alternatives. According to Riley, G. (2006), there is not substantive evidence to support the airline industry of being a natural monopoly. Wage Inequality There is a long history of wage inequality in the airlines industry, though there has been a decline in recent years. In order to address the growing issue nationwide of wage inequality, many states introduced a living wage ordinance which was an effort to control wage inequality. Statistics demonstrate there is a correlation between wage inequality and high turnover. Wage inequality is determined by analyzing the statistics of how much airline employees are making. The living wage ordinances are determined by the cost of living where the airline employee is employed (Zabin, 1999).

According to the

Association of Community Organization for Reform Now (2004), approximately 78% of employees at the San Francisco Airport made under $10 per hour. In 2004 when the living wage ordinance was passed in San Francisco and 99 other cities (Association of Community Organization for Reform Now, 2004), the legislation permitted a wage increase of 33%. Not every single employee benefited from the wage increase, because in cities such as San Francisco where a floor was set of $10 some employees were making the minimum prior to the change and may not be included in this raise. We must keep in mind these rules only applied to non-managerial staff. After changes were implemented, less than 6% of employees were making less than $10 per hour, and 96.7% were making under $14 per hour (Association of Community Organization for Reform Now, 2004).

6 Even know the airline employees in the San Francisco airport make more than the living wage, this is still far below the wage earned by those in other industries in the Bay Area, such those in the technology sector. The airline industry has benefited from living wage legislation because the wage increase encouraged a decreased turnover rate, and a rise in work efficiency. Although no clear formula exists, there are marked trends through statistical analysis of airline employee wages (Button, 2005). Living wage legislation has decreased the incidence of wage inequality. San Francisco was a classic example of wage inequality the majority of employees being in the lowest pay tier. Wage inequality has impacted the entire tourism industry, hotels, and other transportation works have seen similar trends in their reported statistics. Monetary and Fiscal Policies Monetary, fiscal, and federal aviation policies practiced in the airline industry were greatly impacted by the tragic events of September 11, 2001. The affects of the tragedy still live on today through monetary policies introduced from the disaster in addition to the increased security. Immediately after the attacks there was an immediate decrease in demand and there was an increase on the price of tickets, as well as added taxes. Within days there were massive layoffs nationwide to the airline work force and the travel industry experienced similar effects. In addition to the fear of flying in some travelers, people tend to stay home because of the increase in the price of tickets. This dramatic downturn in travel was the cause of many airlines to go bankrupt because they could not fill seats (FRBSF, 2002). If the increasing fares of airline tickets and fear of a repeat attack was not enough,

7 the federal government added an additional fee to the price of a ticket. Not only did the price of tickets increase, but an excess tax was added as a security fee (Button, 2005). "The funds raised through this September 11 Security Fee will be used to implement new aviation security measures to help achieve this most important goal" (Jerram, 1998). Customers were understanding of the new policy, but still failed to respond by purchasing more airline tickets which lead to even more price hikes to the base-ticket price. The September 11th tragedy and newly implemented policies had a dramatic affect on the airline industry. The layoffs in the airline industry were severe; many airlines implemented a hiring freeze. The government is receiving enough funding for right now, but there is still a growing need for updated technology to meet the needs of our security. Credit has been given to deregulation and competition for growing the in the airline industry (FRBSF, 2002). Monetary & Fiscal policies are the two major tools of stabilization policies. Monetary Policies were carried out by the central bank of a nation which regulates the supply of money and credit. Fiscal Policy refers to the power of the federal government to tax and spend in order to achieve its goals for the economy. When the economy is in recession, expansionary monetary & fiscal policies were used, while to control the overheating economy, concretionary monetary & fiscal policies were used (FRBSF, 2002). Increased money supply will reduce the interest rate which leads to higher investments. This is applicable for the airline industries also. Many private companies are now entering this industry which increases the competition & efficiency of airline industry. Deregulations & decentralizations now become two key issues of this industry.

8 Due to high competition, price will be lowered so that demand for airlines will increase. Thus, both expansionary monetary polices & fiscal polices can be used to promote the growth of the airline industry. In conclusion, the airline industry is impacted by current market trends, and externalities. All trends market trends have an impact on the airline industry, when the airline industry is hit directly it affects changes in the market. Due to market dependency, experts view the industry as being very unstable. Many airlines fail to survive when negative externalities strike the airline industry directly. Positive externalities allow people to take future changes for granted and unrealistic expectations are developed. The elasticity of demand is determined by competition, which would be other sources of transportation such as cars, buses, boats, and trains. The current market conditions affect the overall demand for airline tickets and the base-price per ticket. Vulnerabilities that are existent in the airline industry are not realized until a tragedy takes place. There was mass hysteria throughout the market, after the airline industry was targeted directly and there was no backup plan which caused many employees to lose their job as a result of the drop in demand. After the September 11th tragedy occurred, the Department of Homeland Security made the decision to introduce the September 11th Security Fee, which was a monetary policy that many customers disliked due to the increased ticket price. Many people viewed this as a beneficial trade off for their personal safety eventually, and because of that realization the rate of travel has risen significantly since September 11, 2001.

References

9 Airlines say jobs at stake if fee hike approved. (2005). Retrieved January 12, 2008, from USA Today: http://www.usatoday.com/travel/news/2005-02-11airline-security_x.htm Button, K. J. (2005). Airline Taxation. Retrieved January 12, 2008 from http://www.gmupolicy.net/transport2003/airlinetaxation.pdf Econ FAQs. (2007). Air Transport Association, Retrieved January 15, 2008, from http://www.airlines.org/economics/specialtopics/Econ+FAQs.htm FRBSF. (2002). Economic Letter. Retrieved January 21, 2008, from FRBSF: http://www.frbsf.org/publications/economics/letter/2002/el2002-01.pdf Jerram, R. (1998). The Airline Industry. Retrieved February 5, 2008, from London School of Economics and Political Science: http://www.mega.nu/ampp/PEGB/chap11.htm Riley, G. (2006), Externalities - Government Policy Options, Retrieved on February 12, 2008 from: http://tutor2u.net/economics/revision-notes/a2-microexternalities-policy-options.html Recent Policy Initiatives to Raise Low Pay. (2004). Retrieved February 10, 2008, from ACORN.ORG: https://www.acorn.org/index.php?id=203 Zabin, C. (1999). Living Wages at the Port of Oakland. Retrieved February 14, 2008 from http://www.iir.berkeley.edu/livingwage/pdf/portoak.pdf