(picture from Wix's library)
Hello everyone! This month’s article relates to unit 3 of Microeconomics: Elasticities. You can find the course here: https://www.udemy.com/principles-of-microeconomics-complete-course/
You may have heard of Ryanair’s scandal last month. The company was forced to cancel a significant amount of flights because of a lack of availability of their pilots. The reason why they did not have enough pilots is a matter of debate but the impact on the medium and long-term health of the company is fairly clear: no impact whatsoever.
Another example is United Airlines, which had their share of scandals this year: from asking a passenger to pee in a cup to the death of a giant rabbit on their flight… let’s not forget knocking down and kicking out a passenger that had paid for his ticket, was calmly seated, and did nothing wrong! This is just in 2017… and once again it seems that the company is recovering very well from these problems!
The demand for these airlines stays strong as the quality of their product (reliability and customer services in these cases) falls, what is going on? Can Economics explain this curious event?
Of Course!!!!!!! I can explain everything related to human choices… well… please don’t quote me on that!
First, a little reminder: Elasticity measures the reaction of an output to a change in one of its inputs. For consumers, we saw price elasticity, cross-price elasticity, and income elasticity.
Price elasticity of demand measures the change in quantity demanded in reaction to a change in the price of the product. Cross-price elasticity of demand measures the change in quantity demanded in reaction to a change in the price of a related product. Finally, income elasticity measures the change in quantity demanded in reaction to a change in income of the consumer.
These concepts are not enough to understand what is going on in our current case of the airline industry… Hey, let’s just make out own!
We can build a new type of elasticity: let's call it 'quality elasticity’. It measures the change in quantity demanded in reaction to a change in quality of the product. A high value means that quantity demanded reacts strongly to any change in quality while a low value, as in our examples, means that consumers don’t react much to changes in quality (or displays of a lack of quality).
SO, we built a new way of measuring market reactions, but I have not explained what happened yet!
Why is the quality elasticity so low in the airline industry if there is plenty of competition? Can’t consumers just go to another airline if one has a bad reputation?
It’s a bit more complicated than that: this market has at least two separate supply curves. One offering low-quality services and another one offering high-quality services. Products can be from the same category (airlines in this case) but from different markets. Consumers can find them different enough so that they don't consider them substitutes.
In this market, lower income individuals have fewer options. According to AirlineProfiler, low-cost (and low-price) Airlines accounted for less than a quarter of all airlines worldwide in 2013. Fewer options means that consumers cannot easily change products when there is a problem. For them, quality of service is not a high factor in choosing an airline when compared to price.
As you may imagine, higher income individuals have a lot more to choose from. In addition, the quality of service tends to be much higher on average, which means that these consumers can just change airline if they are not satisfied with the service they receive.
Consumers with lower income tend to react very strongly to any change in price, which means that their price and cross-price elasticities are high, but they tend to react mildly or not at all to changes in quality. This is often the case because they don't have enough budget to buy other products of better quality.
For consumers with lower income, buying a product of a higher price brings a big opportunity cost. Every extra dollar they spend on this product means that they have to give up consuming a significant number of other products.
Consumers with higher income tend to react mildly to any change in price, which means that their price and cross-price elasticities are low, but they tend to react strongly to any change in quality. Those consumers have access to most or all products of the market and they can choose whichever gives them the most satisfaction.
For consumers with higher income, the opportunity cost of paying more is very low since they have enough budget to buy most of what they want. These consumers will have to sacrifice products that have a small impact on their wellbeing.
Economics gives us the tools to analyse what people chose under different situations. You can use the Economic method to create new models adapted to each situation you encounter!!!!
I hope you guys enjoyed!