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.  

(a) Discuss whether the demand for cars is likely to be elastic or inelastic with respect to price and income. [10]

(a) With reference to the market for private transport in Singapore, discuss whether the demand for cars is likely to be elastic or inelastic with respect to price and income. [10]

This essay discusses whether the demand for private cars is elastic or inelastic, with respect to both price and income. First, some definitions are in order. Price elasticity of demand (PED) measures the responsiveness of quantity demanded to a change in the price of the good, ceteris paribus. It is calculated by taking the percentage change in quantity demanded over the percentage change in price, ceteris paribus. Also, income elasticity of demand (YED) is defined as the measure of the responsiveness of demand to a change in income, ceteris paribus. It is calculated by taking the percentage change in demand over the percentage change in income, ceteris paribus. This economics paper discusses whether the demand for private cars is likely to be elastic or inelastic with respect to price and income, using the concepts of PED and YED.

Firstly, let us discuss PED, and whether the demand for cars is elastic or inelastic. According to economic theory, demand is likely to be relatively more elastic if a good is not considered a necessity, and more inelastic if a good is considered a necessity. Firstly, with a well-developed public transportation network, Singapore residents have many alternatives or substitutes to driving as they can travel to almost any part of the country by bus, train, or taxi. With the new Circle Line and the upcoming Downtown Line in Singapore, the public rail network has become even more comprehensive and provides wide reach and access to the public. Given the ready availability and accessibility of public transport in Singapore, there are viable substitutes to travelling by car, and thus private transport is definitely not a necessity but more of a luxury. So the overall demand for private cars is arguably likely to be price elastic.

Secondly, according to economic theory, demand is more likely to be relatively more elastic if it takes up a larger proportion of one's income, and vice versa. Also, for most households, the combined cost of car ownership and usage due to the monthly installments for the car loan, car park fees, maintenance costs, and the ERP (Electronic Road Pricing) charges typically forms a large proportion of their income. If a good forms a large proportion of one’s income, then the demand for the good tends to be more price elastic, and therefore, it can be strongly argued that the demand for cars in Singapore is likely to be price elastic as well, given the high costs of car ownership and usage taking up a large proportion of one's income. 

However, for some people, public transport is arguably not a close substitute, and driving is considered as a necessity, perhaps because they are rich enough to be more than able to afford a car, or perhaps they work in areas which are simply too inaccessible by public transport. For example, air force pilots tend to work in far-off places, as airbases are often not easily accessible by public transport. Hence, for such higher income individuals, or individuals who work in inaccessible places, their demand for cars is probably less price elastic. Also, for richer individuals and households, the cost of car ownership and usage forms a smaller proportion of their income so their demand for cars is also arguably possibly less price elastic.

Secondly, let us discuss YED, and whether the demand for cars in Singapore is income elastic or inelastic. A normal necessity good has 0 < YED < 1, which means that it is income inelastic, while a normal luxury good has YED > 1, which means that it is income elastic. Compared to other transport modes like buses, trains, and taxis, private cars are likely to be perceived by most people to be the highest quality among all the various modes of transport because cars are simply faster, more comfortable, and offer more privacy. Hence, when income rises, people are more likely to switch away from other transport modes to travelling by private car. Hence, a private car in Singapore is likely to be a normal luxury rather than a normal necessity. Thus a rise in income leads to a more then proportionate increase in demand for private cars.

However, as income rises, car buyers tend to upgrade from smaller cars to bigger and more luxurious ones, for example from Cherry QQs to BMWs, and also from less prestigious brands to more prestigious ones, so higher end car models and brands tend to be more income elastic.

In conclusion, the demand for cars is likely to be price elastic, and at the same time, it is also likely to be income elastic. In Singapore, with a dense transport network for a small land area, people will view public transport as a viable alternative to cars, making the demand for cars relatively more price elastic. Furthermore, car costs are a large proportion of people's incomes in Singapore, given the high costs of car ownership and usage charges in Singapore. On the other hand, car buyers as a whole are much richer than most segments of Singaporean society, and would tend to switch to buying more luxurious cars with an increase in income. This is supported by the fact that Singapore’s economic growth was high in 2011. Hence, in the final analysis, my view is that the demand for cars in Singapore is likely to be price elastic and income elastic.

H1, H2, H3 A levels JC Economics Essays - Tutor's Commentary: This is a very well structured, clear cut, and well written economics paper. It was edited only for some simple grammar, spelling, and typos issues, but composed mainly by the student, given her understanding of the issue and the context. Observe the excellent use of examples that are pertinent to Singapore's case and context, which addresses the requirements of the essay question. At the same time, observe the Economics behind the writing - there is solid economic theory at the A level standard. A well-written, well-thought out economics paper should look something like this ... but also do remember as usual that in my website Economics diagrams are not included. Should there be a diagram here? Why should there be a diagram, and why not? What economics diagram would you draw, and what would it show exactly, and why? Think about it. Perhaps you should also read the next post, which addresses the next part (part (b)) of the essay question. Always bear in mind that you should read with a critical, thinking mind. Thanks for reading and cheers. 

Special thanks to AG for her kind and useful contribution. She achieved a grade A for her H2 Economics at A levels and then proceeded to the Nanyang Technological University to read mathematics, on a Ministry of Education Teaching Award. 

(b) Examine how the car producers might use the price and income elasticity of demand concepts to help determine pricing and output decisions. [15]

Singapore’s car population grew by almost 40% from 370 000 in 1997 to 515 000 today. - Adapted from Singapore’s Ministry of Transport

(b) Examine how the car producers might use the price and income elasticity of demand concepts to help determine pricing and output decisions. [15]

Car producers can use the price and income elasticity of demand concepts to help determine pricing and output decisions. This essay discusses how car producers can use the concepts. First, PED measures the responsiveness of the quantity demanded of a good for a given change of its price, ceteris paribus. On the other hand, YED is defined as the responsiveness of the demand of a good to a change in income, ceteris paribus.

First, PED can be used to help firms. Let us assume that firms aim to maximise total revenue. If demand is price elastic, as prices fall, this will lead to a more than proportionate increase in quantity demanded, which leads to a rise in total revenue. On the other hand, if demand is price inelastic, as prices rise, there will be a less than proportionate fall in quantity demanded, hence raising total revenue also. The implication here for car producers is that they can make use of this knowledge to determine their pricing strategies.

For example, the many major car producers have competitors producing similar products e.g. Toyota, Volkswagen and Hyundai. Therefore, such cars are relatively elastic in demand because they have many substitutes. Therefore such producers should lower the price to increase total revenue.

On the other hand, some exotic or luxurious car producers such as Ferrari or Rolls Royce have fewer competitors and very a differentiated product, so the demand for their cars is relatively price inelastic. Hence, such car producers should lower raise the price to increase total revenue.

YED is also useful to car producers. Normal goods have positive YED, where a normal necessity has a YED between 0 and 1, whereas a normal luxury good has a YED of more than 1. A normal good is defined as any good whose demand increases as income increases, where a necessity has a demand curve that increases less than proportionately to an increase in income, whereas a luxury has a demand curve that increases more than proportionately to an increase in income. Hence firms should produce more normal goods in general if the general level of income rises in an economy.

On the other hand, inferior goods have negative YED. An inferior good is defined as any good whose demand increases as income decreases. Hence, firms should produce more inferior goods when there weak economic growth and income decreases.

Also, the higher the magnitude of YED, the greater the extent of the change in demand and hence the more the firm should respond in producing output. For example, Geely and Cherry QQ are inferior goods and more should be produced in a downturn, whereas Nissan and Toyota are normal (can be considered normal necessity) goods and more should be produced in an upturn, and Ferrari and Porsche are normal luxuries, and even more should produced in an economic upturn. Therefore, even the extent of the change matters when it comes to producing output.

In conclusion, PED and YED are very useful concepts for car producers. On the other hand, it is more likely that producers may aim to maximise profits than revenue, hence, knowing elasticity is insufficient because we also need to consider costs. Total profit is equal to total revenue minus total cost. Furthermore, elasticities are estimated based on past data, and therefore may not be very useful if current economic conditions have changed drastically. Hence, in my opinion, elasticity concepts – while important – need to be understood in their nuances.

Junior College Economics Essays - Tutor's Commentary: This is the second part (part (b)) of the question addressed earlier, written by the same hardworking, clever student of mine, and was written under timed, stressful, examination-like conditions. (Of course, he did write the paper after consultation with me, and then I did work through the paper again to clean it up and improve upon our joint project... but that's another story.) The real question is: is it possible to write this under examination conditions? The ANSWER: It is definitely possible to craft a paper of this standard or EVEN better whilst under examination conditions during the A levels. However, do remember to add in diagrams (what diagrams would be really useful here?) and explain those diagrams to convince your Economics examiner to give you a really good grade.