Winnie

Analyse how an airline operator could estimate the elasticity of

demand for its services.
Evaluate the significance of this knowledge for the firm in making
its pricing decisions to maximize its revenue when operating
in the highly competitive NZ airline industry
In your answer:
(i)
Analyse how an airline operator can benefit from
knowledge of each of the three elasticities of demand when
making its pricing decisions.
(ii)
Discuss the factors that might help an airline operator
determine the level of elasticity of demand for its services
(ie PED, XED, YED)
(iii) Evaluate the importance of this knowledge to an airline
operator in maximizing its revenue in the long run.
Airline operators can benefit from knowledge of each of the
elasticities; Price, Income and Cross elasticity of demand. Firstly,
Price elasticity of demand measures the responsiveness in quantity
demanded when there is a change in price. The price elasticity of
demand is beneficial to airline operators as it demonstrates either
elastic or inelastic demand. Inelastic demand means there is little
response to demand of air travel when there is a change in price
resulting in a coefficient less than 1, whereas elastic demand has a
big proportionate change in demand for air travel when there is a
change in price, resulting in a coefficient greater than 1. For
example, in resource A, it shows elastic demand for leisure travellers
with price elasticity of demand coefficients of 1.1 and 1.4 while
business travellers demonstrated inelastic demand with coefficients
of 0.8 and 0.2. The elasticity shows a direct correlation between the
purpose of travel. Leisure travellers demonstrate elastic demand
because its not a necessity for them to travel around a particular
week or day, so they can easily change plans and day of travel.
Therefore, they are very responsive to changes in the price of air
travel. On the other hand, business travellers demonstrate inelastic
demand to air travel, because it is necessary for them to travel
within a certain time period, because it is necessary for them to do
so. As a result, they have little response to changes in the price of
air travel. This is very beneficial to airline companies to maximize
their revenue in the long run, as they can use price discrimination
on air travellers, based on whether their demand is elastic or
inelastic. As explained by resource E, Price discrimination is the
action of selling the same product at different prices to different
buyers, in order to maximize sales and profits. For example, in
Resource C, we can see that air travel firms can discriminate based
on identity of the traveller, destination, time of departure and time
of return. The knowledge of these help air travellers to accurately

discriminate air travellers to help them maximize their profits in the

long run.
Income elasticity of demand measures the responsiveness in
quantity demanded when there is a change in consumer income. For
example, if housing prices rise, consumer confidence of air
travellers is increased as they feel more wealthy, and therefore are
willing to dispose of their extra income on luxuries such as air travel.
Another example is airline companies can gather information from
the economy such as inflation- a general increase in the price level
of goods and services of an economy. As inflation decreases,
consumers feel as though they have more disposable income that
they are willing to use. Airline companies can also calculate the
coefficents for the income elasticity of supply where coefficients less
than one demonstrate inelastic demand, and coefficients greater
than 1 demonstrate elastic demand, as earlier mentioned before.
With these elasticities, theyre also able to use price discrimination.
From resource D we can see that firms are able to use this
information depending on the time throughout the year to charge
extra money to maximize total revenue with extra bag charges
meals on flightspriority screening, early boarding. For example,
charging extra prices for priority boarding, meals on board and air
travel ticket prices during a period of
economic boom- a period of rapid
economic expansion resulting in higher
GDP, lower unemployment and rising
asset prices. Airline companies benefit
from the knowledge of income elasticity
of supply, because depending on the
state of the economy during a certain
period, they are able to make strategic
price decisions to maximize total revenue.
Cross elasticity of demand measures the responsiveness of the
quantity demanded of good X, when there is a change of price in
Good Y. Good X and Y must be related, such that they are either
complements or substitutes. In this case, we look at the effect on
one airline, when another airline company changes their prices.
Airline operators can benefit from the knowledge of cross elasticity
of supply, because based on this, they can construct which method
of Pricing Competition to use towards other companies, in order to
maximize total revenue for their own. For example, from resource G,
we see that based on cross elasticity of supply, Jet Star has chosen
to challenge competitors in the same industry through a price warin which they cut prices in an attempt to increase their share of the
market. In this example, Jetstar offers one cent flights to battle to
be the cheapest airline. From the resource we are able to see that
Air New Zealand suffered greatly from the price war of the

Australian company Jetstar, so in order to counter this, they too

engaged in price war, offering tickets as cheap as $7 each way.
Here, price war has helped Air New Zealand to choose a price that
brings back their share of customers. Other factors that might help
an airline operator determine the level of elasticity of demand for
its services can be determined by their loss of customers.
Overall, we are able to see the importance of knowledge each of the
three elasticities, Price, Income and Cross elasticity of demand.
Through these, we are able to identify factors that help an airline
operator determine the level of elasticity of demand for its services.
Knowledge of these influencing factors are able to help airline firms
develop informed strategies in maximizing their revue in the long
run.