Explain how the worldwide recession of 2008-2010 and the closure of some major airlines of the world after September 11th affected the market for air travel, and assess the relevance of various elasticity concepts in explaining the effects of these events on the airline industry as a whole. [25]

Note: This (theoretical) sample economics essay shows you how to systematically and methodically deal with Multi-Part, Complex Economics Essay Questions with Several Areas of Discussion to Address

Essay: 

To begin with, it is important to identify that the recession would have led to a drop in demand for air travel, while the closure of some of the major airlines would imply a fall in supply of air travel. Therefore, this essay will talk about the different permutations of a simultaneous fall in demand and supply, and their effects on the price and quantity output of air travel, with the aid of a diagram. Additionally, it will also be analysed in context why both the demand and supply of air travel had fallen.

Although both the demand and supply of air travel had fallen, it is important to note that relatively, if the demand had fell more than the supply and vice versa, the resulting price of air travel will differ.

[Insert diagram on fall in supply > fall in demand]

[Insert diagram on fall in supply < fall in demand]

From the first diagram, it could be seen that if the drop in supply was greater than the drop in demand, price rises, while quantity falls. However, in the second diagram, if the drop in demand was greater than the drop in supply, both price and quantity falls. These hence summarises the varying effects of a fall in both demand and supply on the market for air travel.

Moving on, it will be analysed in context why did the recession and the closure of major airlines lead to a fall in demand and supply of the air travel.

Firstly, it has to be taken into account that the demand for air travel is a derived demand, derived from the demand for vacations and business-related trips. In the case of a recession, the world’s income falls, thus significantly reducing the demand for vacations. Furthermore, with a recession, business activity slows down in tandem with the slowdown of the economy. This implies a fall in demand for business trips as well. Together, the fall in demand for both vacations and business trips means that the derived demand of air travel falls as well.

Additionally, the closure of some major airlines implies a reduction in the number of operating firms and hence the number of available flights. This ultimately leads to a fall in the supply of air travel.

In conclusion, for the first part of the question, the recession and closure of major airlines affected the air travel’s market via a fall in both demand and supply of air travel. However, there are varying effects depending on the relative extent of the fall of demand and supply.

The second part of the question requires the analysis of the extent of relevance of the various concepts of elasticities in explaining the effects of the worldwide recession, the increased fear of flying and the closure of some of the major airlines on the airline industry. Therefore, this part of my essay will explain the various concepts of elasticities in context, before concluding with some limitations of the use of elasticities.

Price elasticity of demand measures the responsiveness of quantity demanded of a good to a change in its prices, ceteris paribus. It is calculated by taking the percentage change in the quantity demanded of the good over the percentage change in its price. Therefore, it affects the gradient of the demand curve. The steeper the slope of the demand curve, the more price inelastic is the good. In context, the fall in supply of air travel arising from the closure of some major airlines will result in a rise of price of air travel. However, since there are no close substitutes for air transport (as the speed of other forms of transport are not comparable), especially for long distance travel, the demand for air travel is likely to be relatively price inelastic. Hence, the rise in price of air travel will lead to a less than proportionate fall in quantity demanded for air travel.

Income elasticity of demand measures the responsiveness of the demand for a good to a change in income, ceteris paribus. It is calculated by taking the percentage change in demand for a good for a given percentage change in income. For normal goods, income elasticity of demand is positive as when income increases, demand for the good increases and vice versa. Normal goods could be further divided into necessities and luxury goods, where the former’s demand rises less than proportionately with a rise in income, while the latter’s demand rises more than proportionately. There are also inferior goods, where demand of the goods drops with a rise in income.

[Insert diagram on falling demand curves]

In context, vacations are largely a luxury good for most households, thus they are income elastic. Thus, with the recession and thus fall in income, the demand of vacations is likely to have a more than proportionate fall. On the other hand, business trips are more likely to be unable to be put off in the short run, thus they are more income inelastic and hence demand is likely to fall to a smaller extent when income falls. However, in the long run as business activity slows down, business trips will not be required, thus they may become income elastic. Therefore, in the long run, the demand for air travel is likely to be income elastic, implying a more than proportionate fall in demand, with a fall in income arising from the recession.

Price elasticity of supply measures the responsiveness of quantity supplied of a good to a change in its price, ceteris paribus. It is calculated by taking the percentage change in the quantity supplied of the good over the percentage change in its price. Therefore, it affects the gradient of the supply curve, the steeper the slope, the more price inelastic is the supply. In context, the fall in demand for air travel results in a fall in price of air travel. However, since most flights have been scheduled months in advance so planes will fly even if demand falls, thus in the short run supply of air travel is rather price inelastic. This means that there will be a less than proportionate fall in quantity supplied of air travel with a fall in price. However, the same does not hold in the long run. In the long run, airlines close down if subnormal profits are incurred; hence rendering the supply of air travel price elastic. This leads to a more than proportionate fall in quantity supplied with a fall in price of air travel.

           

Lastly, cross elasticity of demand measures the responsiveness of demand for a good to change in price of another good, ceteris paribus. It is calculated by taking the percentage change in demand for the good for a given change in price of another good. Substitutes have positive cross elasticity of demand while complements have negative cross elasticity of demand. Unrelated goods have zero cross elasticity of demand. Also, the magnitude of the cross elasticity of demand suggests how strong the goods are as substitutes or complements to each other. However, cross elasticity of demand is not relevant in this context as the preamble did not mention a change in price of related goods.

In conclusion, with the exception of cross elasticity of demand, the various elasticity concepts are largely relevant in explaining the effects of the events on the airline industry. Despite this, there are certain limitations. Firstly, elasticity concepts will not be suitable to measure the fall in demand caused by the fear of flying, since such change in preferences against air travel is intangible and unquantifiable. Hence the relevance of such concepts to explain the effects are largely limited since the fear of flying most likely accounts for the large part of the fall in demand. Furthermore, since elasticity figures can only be estimated based on past data, it may be inaccurate to use such to foresee the effects of current events since economic conditions would have changed.

JC Economics Essays - H1 and H2 standard 'A' Levels Economics Essays - tutor's comments on this essay - Basically, there are times in an examination when the examiners ask multiple parts in one single question. This essay simulates combining two essay parts (usually a part (a) and a part (b) essay) into one essay, and the best way to address it is to imagine that it is indeed two parts - and answer each part accordingly. There are several other essays on this site that are similar to this one, but  are in the part (a) and part (b) version, and the style would be different for each. Think about how you could improve on the method suggested above. Special thanks to A.G. for her contribution, as well as the econs students behind this very impressive work.  

Assess the relevance of price elasticity of demand, income elasticity of demand, cross elasticity of demand and price elasticity of supply in explaining the effects of a worldwide recession and an increased fear of flying on the airline industry. [15]

Apart from considering how changes in price is affected by the changes in demand and supply, it is also important to take into account the responsiveness to the change in price, income and other goods. Thus, this essay aims to discuss the relevance of the various elasticities of the changes in demand and supply and the limitations of the concept. 

Price elasticity of demand measures the responsiveness of quantity demanded of a good to a change in its price, ceteris paribus. The demand for a good is said to be price elastic if a given percentage change in its prices causes a more than proportionate change in its quantity demanded, ceteris paribus. Conversely, the demand for a good is said to be price inelastic if a given percentage change in its price results in a less than proportionate change in its quantity demanded, ceteris paribus.

[Insert a diagram with both elastic and inelastic demand curves]

As shown, the steeper the demand curve, the more price inelastic. A fall in price will result in a more than proportionate increase in quantity demanded for good that is price elastic. Conversely, given the same decrease, it will result in a less than proportionate increase in quantity demanded for a good that is price inelastic.

Secondly, income elasticity of demand measures the responsiveness of the demand for a good to a change in income, ceteris paribus. Positive income elasticity of demand refers to the increase in demand for good when income increases. Such goods are known as normal goods. Normal goods can be sub-divided to normal-necessity and normal-luxury good. A normal-necessity good is income inelastic, which means that a rise in income will result in a less than proportionate change in demand whereas a normal-luxury good is income elastic, which means that a rise in income will result in a more than proportionate change in demand.

Negative income elasticity of demand refers to the decrease in demand for good when income increases. Such goods are known as inferior goods. Inferior goods occur because rising income levels cause consumers to switch from lower quality product to a higher quality product as they are able to afford better alternatives.

 

Cross elasticity of demand measures the responsiveness of demand for a good to a change in price of another good, ceteris paribus. Positive cross elasticity of demand means the demand for a good and the price of another good change in the same direction. This suggests that the goods could be substitutes. Negative cross elasticity of demand means that the demand of a good and the price of another good changes in the opposite direction. This suggests that the goods could be complements.

Price elasticity of supply measures the responsiveness of quantity supplied of a good to a change in its price, ceteris paribus. The supply of a good is price elastic if a given percentage change in its price causes a more than proportionate change in its quantity supplied. Conversely, the supply of a good is said to be inelastic if a give percentage change results in a less than proportionate change in its quantity supplied.

[Insert a diagram with both supply elastic and inelastic curves]

As shown, the steeper the supply curve, the more price inelastic. A fall in price will result in a more than proportionate decrease in quantity supplied for a good that is price elastic. Conversely, given the same decrease, a price inelastic good will show a less than proportionate decrease in quantity supplied. 

In the context of price elasticity of demand, the elasticity of air travel can be analysed using the factors that affect price elasticity of demand, such as availability of substitutes, degree of necessity and proportion of income.

Firstly, the greater the availability of substitutes and the more homogenous the good is, the higher the price elasticity of demand. In terms of air travel, there is no close substitute that is as efficient and as fast as the plane when travelling long distances. In order to travel across the latitudes, there is almost no close substitute for air travel. Hence, air travel can be considered price inelastic of demand. However, some may argue that in the case of short distance travelling, there are substitutes such as trains, cars and public transports that may be as efficient on a well-developed transport network system. Hence, the degree of substitution may differ and is subjective. 

Secondly, the higher the degree of necessity, the lower the price elasticity of demand. Since air travel is usually for leisure and relaxation, the degree of necessity may be low for most households that go on a vacation for leisure. Hence air travel can be considered as price elastic of demand. However, the degree of necessity is debatable especially in the case of businessmen as air travel may be a necessity in order to improve sales or make profits. Thus, in this case, air travel is price inelastic of demand. 

Thirdly, the larger the proportion of income spent, the more price elastic. Air travel is usually costly, especially when it is long distance or for longer period of time. Hence, it is price elastic. 

In the context of income elasticity of demand, air travel is considered normal luxury good for most households hence it is considered income inelastic. However, some may consider air travel as a normal necessity especially when business travelling is concerned. Thus, whether a normal good is a necessity (income inelastic) or is it a luxury (income elastic) depends on individual. 

In the context of price elasticity of supply, it can be explained via a long run and short run concept. In the short run, air tickets are booked in advance and cannot be cancelled immediately, supply is fixed, and hence supply is less elastic. However, in the long run, people’s fear of flying may cause a decrease in supply since demand is extremely low. Hence, supply becomes more elastic.

However, there are limitations of applying the demand elasticity concept. In this situation, the fear of flying cannot be measured by elasticity as the changes in tastes and preferences are un-quantifiable. Thus, the impact is not taken into consideration causing the fall in demand to be less than expected, especially in the long run. In addition the cross elasticity is inapplicable as there is no close substitute. The various elasticities are also derived from past data that may be outdated and hence inapplicable for current economic situation.

In conclusion, responsiveness towards changes in price increase is not constant due to the changing economic situation and in reality, several other factors are also able to influence the elasticity instead of being ceteris paribus. Thus, the effect on the airline industry can be only explained to a certain extent.

JC Economics Essays – H2 A levels – Economics tutor’s comments: This economics paper seeks to address the adapted examination question on elasticities and their relevance, to a specific context. This paper develops the arguments and ideas around the economics question, which is good - always answer the question posed. As it is a part (b) question adapted from an A level Economics question, there was an earlier part (a) to it which dealt with explaining the various elasticity concepts on offer. As an assignment or a training exercise, perhaps think to yourself or check out the various definitions - definitions (as well as mathematical equations) for the various types of elasticities: PED, YED, XED (or CED), and PES. What good points are there to praise about this economics paper? A thesis, anti thesis, and synthesis approach to the essay is clearly and obviously used, which should please practically all Economics tutors and examiners when they are marking. It might be a very good idea to make examiners happy when grading papers. However, there are a few simple problems with this economics essay. First, the conclusion is a bit too concise and does not push the envelope, and certainly could be improved upon. How could you help this candidate improve on her conclusion, by writing it better? Also, what other aspects of this essay could be improved upon - what have you noticed is missing from this essay that could have been written in? Think about it. Special thanks to the kind, valuable, and beautiful contributions of AG and other students for this economics blog.