Economics/ped and xed
hi! what is the relevance of price elasticity of demand and gross elasticity of demand to an airline company??
As you might already know, Price Elasticity of Demand (PED) is a ratio measure of the amount of change in demand caused by a change in price. dD/dP, where d = delta (meaning percentage change), D = demand, and P = Price.
If price goes up 1% and demand goes down 1%, that's called unit elastic.
If price goes up 1% and demand goes down more than 1%, that's called elastic. A company will benefit most from decreasing price at these levels because the increased demand will generate more income through increased revenues than the company will lose in decreased profitability.
If price goes up 1% and demand goes down less than 1%, that's called inelastic. A company will benefit most from increasing price at these levels because the increased profitability will generate more income than the company will lose through lost demand.
If price goes up 1% and demand drops to 0, that's called perfectly elastic. This is found only i a state called perfect competition, which is common in many commodity producers.
If price goes 1% and demand does not change, that's called perfectly inelastic. The closest thing is found in industries like healthcare, food distribution, and energy.
The demand curve for a single company will have points of all degrees of elasticity. As price goes down, PED becomes more inelastic. As price goes up, PED becomes more elastic. There is a tendency for all goods to maintain price that floats somewhere around unit elastic.
There is also a few special cases wherein PED can be a positive ratio, instead of negative. Giffen goods, inferior goods, and investments, for example.
Cross elasticity of demand compares the price of one company to the demand of another. dD1/dP2, where d = delta, D1 = demand for company 1, and P2 = price for company 2.
So, an increase in the price of Pepsi will cause an increase in the demand for Coke.
Regarding the airline industry, since airlines have a fixed number of seats to fill per flight, it is in their best interest to set prices at a level that fills as many seats per plane as possible, while limiting the number of planes used, in order to decrease the amount of capital inefficiency. They also need to take into consideration their pricing compared to their competitors in the airline industry, and alternative travel options such as train and car, both of which are increasing in popularity around the world thanks to improvements in technology such as bullet trains, and rampant problems with the airline industry. This will, in the long run, require airlines to decrease their prices, which will force them to reorganize in a manner that increases their efficiency. Examples include airlines such as Southwest and JetBlue, both of which deviate greatly from the standard operations and logistics of more traditional airlines.
Hopefully that answers your question.