Price elasticity of demand is a term commonly used in economic and business studies to mean an elasticity that measures the degree of the relationship between variation in quantity demanded of a good and variation in its price. In most cases normal goods and most inferior goods price drops results into increase in the quantity demanded. But goods for which there is no substitute are generally inelastic. This type of demand is relatively associated with necessities. However, products with a high elasticity in most cases have many substitutes. (Karl 1999)
In the case of Southern Airline, there are various airlines that operate through the same part of America. Thus there are a number of substitutes in the area which means that the demand is elastic. If for example the company charge too much on its tickets, people are likely to move to the other forms of air travel in Texas. (Karl 1999)
Demand for giffen goods or Veblen goods are considered to increase with increase in price. First class air travel happened to rank in the classification of giffen goods (goods whose demand increase with increase in price) so I would advice you to increases the price of the first class tickets but not for the ordinary class passages. (Henderson 2004)
On the other hand, there is a case of price inflation, during an economic bubble, consumer perception have a crucial role in explaining products’ demand in some categories. If for example you increase your prices, customers may come on the perception that you are charging higher because you are offering higher quality services. This in return will have a positive impact on the company’s revenue. (Karl 1999)
Price elasticity demand is affected by a number of factors but all of them are under one umbrella the ‘choice’. By choice we mean the power of choice the consumers of a certain good holds to give up the consumption of the said good. All this is due to consumer’s ‘perceived value’ like first class those customers value their prestige and will not do without it. So I would advice you to increase the 1st class ticket prices. Also, on the other classes based on the principle of price inflation during an economic bubble you can increase the price believing that people will perceive that there is quality improvement and respond positively thereby increasing the overall revenue. (Sowell 2004)
Air travel is a basic necessity to some long distance travelers in America. This means that if price is increased they will probably not change their mode of transport. Thus change in price is not likely to affect much the change in demand since the elasticity of the product is not too elastic. I would advice you to increase the price since you offer good quality service, Air travel to some people is habitual and they will still come, most of the people who use air travel have good income and thus they will not be affected or strain financially and thus realize some decreased revenue. (Karl 1999)
Income Elasticity of demand evaluates the responsiveness of quantity demanded of good to the variation in the income of people demanding this good. It is the ratio of the percentage change in quantity demanded to the percent change in income. (Henderson 2004)
In this case, the third class travelers who are the majority have a negative income elasticity of demand. This means that an increase in income will lead to a decrease in the quantity demanded for some specific less luxurious class. Therefore if customer’s income is increased by 10%, they will tend to move to the higher prestigious classes. Also, more people who would like to travel by air and find it economically straining if their income is raised, they would travel by air that means that increase in consumer income by 10% may result to increase in the demand by same proportion. A zero income elasticity of demand would occur in the prestigious class travel. This means that increase in their income will not have an effect on their demand. (Karl 1999)
AN OVERVIEW OF SOUTHWEST AIRLINES
Southwest Airlines was originally started to serve three cities in Texas as Air Southwest back in 1967 by Rolling King and Herb Kelleher. These routes were Dallas, Houston, and San Antonio. It is the largest airline that operates within California, with 694 flights total in the state, 370 of which are intra-California.
Currently, Southwest operates in 64 cities in 32 states, with more than 3,300 flights a day. It has notably large operations in certain airports. These airports operate non-stop flights to more than half of the Southwest system. It also uses other secondary airports which have lower costs which may or may not be, more convenient to travelers than the major airports to the same destinations such as Midway Airport in Chicago and Fort Lauderdale-Hollywood International Airport.
The company offers both the local and international airline services. An average of three quarters of Southwest passengers is local passengers, meaning only a quarter of all passengers are connecting passengers. This is relatively higher than most airlines, where travelers often connect in hub cities.
Southwest Airlines has also set a goal to code share with ATA and begin international codeshare services or ticket for international flights in 2009. Destinations that may be served by this include Canada, the Caribbean, and Mexico
Southwest Airlines also makes exceptions to the philosophy of serving those secondary airports by flying into some larger airports in major cities, such as Phoenix Sky Harbor International Airport.
Success and profitability of this company led to a common trend named after the company as The Southwest Effect. The price in the company may drop when a low fare carrier or any aggressive and innovative company comes into market. They believe that a drop in price not only doubles the customers but may quadruple them.
Southwest has a program to hedge fuel prices. It purchases fuel options years in advance so to smooth out fuel costs variations. This helps the company to take market conditions advantage for example in 2000. It also hopes to take advantage of historically low prices of jet.
According to its 2006 Annual Report, fuel prices have been fluctuating over the past years:
2004 – 82.8 cents/gallon
2005 – 103.3 cents/gallon
2006 – 153.0 cents/gallon www.southwest.com/about us
In conclusion, it can be said that price can be increased in the case of the Southwest Airline under conventional economic assumptions of consumer rationality: that people will look for the quality not the pricing. Also, company has a relatively inelastic demand and the prices will not affect the customers. So it is advisable to raise the price also because the ‘good’ in this case is giffen good.
Karl E. & Ray C. (1999). Principles of Economics (5th ed.). Prentice-Hall Publishers
Henderson, H (2004), Supply and Demand. Kessinger Publishers
Sowell T (2004). Basic Economics: A Citizen’s Guide to the Economy Basic Book Publishers
Smith A (1982), The Wealth of Nations. Penguine Classics