Price Elasticity Airlines the Piece "Airlines Try Essay

Price Elasticity Airlines

The piece "Airlines try cutting business fares, find they don't lose revenue" explains how major airline firms in 2002 cut their business travel fares in an attempt to generate more business "and bring back business travelers who are staying at home, buying in advance or running to discount airlines" (McCartney, S. November 22, 2002). Of particular interest in this dynamic is the effect on total revenue generation resulting from the decrease in prices. Pricing logic might suggest that a decrease in fares would produce a loss in revenue however, in the case of Continental Airlines a fare decrease on a flight from Cleveland to Los Angeles from $2,000 to $716 resulted in Continental generating revenues equal to those at the previous higher rate, while gaining market share (McCartney, S. November 22, 2002). The rationale for this outcome can be explicated by the economic principle of price elasticity of demand.

The price elasticity of demand measures "how much the quantity demanded changes when the price of the good changes" (NetMBA. N.D.).From the law of demand it is understood that as the price of a good falls the quantity demanded will increase, and obversely a price increase in that good will result in a decrease in quantity demanded. The price elasticity of demand provides a value to the magnitude of that change in quantity demanded.The calculation of price elasticity of demand is straightforward: Q2-Q1 / (Q1+Q2)/2 divided by P2-P1 / (P1+P2)/2, and will produce an elasticity coefficient (QuickMBA. N.D.). Succinctly, the calculation is the percent change in quantity demanded by the percent change in price.

In the Continental example the exact value of the elasticity coefficient is not calculable because the change in quantity demanded is not specified however, based on the available evidence the absolute value of the price elasticity of demand can be discerned. From the information provided the drop in fare resulted in an increase in the quantity demanded to such an extent that total revenue did not materially change. This outcome suggests that the demand is elastic "meaning that a price change will cause an even larger change in quantity demanded" (QuickMBA. N.D.), and the coefficient of price elasticity when calculated would be greater than one. Why would this be the case? Demand is typically elastic for goods which are not necessities; clearly business fare travel is not considered a necessity. Secondly demand is more elastic if there are sufficient substitutes for consumers to choose from. Lastly, demand is more elastic in the long- run than in the short run (Mankiw, G. 2004). In this case the consumer….....