Air Transport in the UK - Essay Example

Macro and Micro Economics Table of Contents Table of Contents 2 Factors determining the demand for air transport in the UK 3 2.Income elasti of demand 5 2.1 Concept of Income Elasticity of Demand 5 2.2Difference between Normal goods and Inferior goods 7 3.Impact of cheaper air fares on passengers after a drop in oil price 8 Summary 9 Reference List 10 1. Factors determining the demand for air transport in the UK The demand for air transport is highly responsive to the changes in the price of air travel and income of the individuals. However, the demand elasticity varies according to the location and coverage of the market. Passengers nowadays are becoming increasingly sensitive to the changing price led by the increase in low cost for travelling. Transportation demand is referred to type and number of travel that people choose under certain specific conditions. The quality of available transport options and the associated prices are taken into account (Begg and Ward, 2013). It has been observed that the growth in the UK air transport has increased highly in the past few decades. There are many factors that can affect the demand for air transport in the UK. The factors are being summarized in the table below (Table 1). Table 1: Factors affecting Air transport in the UK (Source: Begg and Ward, 2013) However, there are two key drivers of air transport demand in the UK economy. One is growth in income in the long-term and the other one is fall in the real cost of fares of air transport. With the decline in air fares and rise in income, the passengers are expected to increase their air travel. However, with fall in the air fares, the airlines are unable to cut down operational costs and due to this, the sector has to meet increasing cost for emission of fuels. The figure below shows the key factors of air transport demand in the UK (Sloman, Hinde and Garratt, 2013). Figure 1: Factors responsible for change in air transport demand in the UK (Source: Begg and Ward, 2013) It is to be noted that the demand for air transport highly depends on different income groups of people. The demand elasticity of business passengers is mostly found to be low. This is because; travelling becomes a necessity for them. However, this trend is changing in the UK economy. There has been a decline in the air travel of business class people (Njegovan, 2006). Another group of passengers are the one who travel for their leisure. The studies show that the trend in these types of passengers decline due to rise in air fare and increases with the fall in air fare (Begg and Ward, 2013). They generally expect low fares. The figure below shows the trend of the UK residents who travel abroad for leisure (measured by the length of their stay). Figure 2: Visits to abroad by the UK residents (Source: Njegovan, 2006) Thus, change in air fares and income level of the people is the two most determining factors of demand for air transport in the UK. 2. Income elasticity of demand 2.1 Concept of Income Elasticity of Demand Income elasticity of demand in economics is used to measure the responsiveness of quantity demanded of a good with respect to the income change of the individual demanding the good, holding all other things constant. Mathematically, it is calculated by taking the ratio of change in the percentage of quantity demanded to the change in percentage of income (Palmer and Hartley, 2011). Income elasticity of demand = % change in quantity demanded / % change in income Income elasticity of a good which is greater than 1 (luxury good) is considered to be highly elastic. The good whose elasticity lies in the range of 0 to 1 (normal or necessary good) is considered to be elastic and the one with elasticity less than 0 (inferior good) has negative elasticity. Also, goods having income elasticity equal to 1 is unit elastic. The figure below shows different types of elasticity (Worthington, 2005). Figure 3: Types of Income Elasticity of demand (Source: Worthington, 2005) Therefore, income elasticity differs with the nature of goods. The demand for inferior good is negative, less elastic for normal good and that for luxury good, it is highly elastic. The figure below depicts this concept. Figure 3: Income elasticity of demand for different goods (Source: Worthington, 2005) Now, it is important to know the difference between normal goods and inferior goods. 2.2 Difference between Normal goods and Inferior goods In economics, normal goods are referred to as the goods whose demand increases with the increase in income. On the other hand, inferior goods are those whose demand goes down with the increase in income and vice-versa. The demand for normal goods can be both elastic as well as inelastic. With the increase in income, the demand for normal goods increases; whereas, with the fall in income, its demand decreases. The price for this type of good is constant. A best example can be the amount of food consumed by an individual. For instance, an individual with higher income may go for restaurant food more than the one with lower income level. Contrary to this, the income elasticity of demand for inferior goods is negative. For example, a person would not prefer a bus ride if his income is high. Rather, he would go for taxi or shuttle. Similarly, if the income goes down, the person would prefer bus ride rather than travelling in a taxi (Sloman and Jones, 2014). Thus, bus ride here is an inferior good. Implication of income elasticity of demand for a) Budget: The passengers’ demand for air transport increases with the rise in income level and falls with decrease in the level of income. However, the demand for airlines also depends on the air fares. With fall in fare of airlines, the consumer’s demand for air travel goes up. The airline industry of the UK has been dominated in the current years due to the rise of LCCs (Low Cost Country). However, the market has significantly grown due to the low air fares, increase in competition and options to choose from more number of destinations. During the global crisis, the growth trend of passenger traffic was found to be declining. This is because during recession the income of the people goes down leading to a fall in the demand for air transport. The figure below shows passenger traffic of UK-Europe during the period 1991-2013 (Civil Aviation Authority, 2010). Figure 4: Passenger traffic of UK-Europe during 1991-2013 (Source: Civil Aviation Authority, 2010)) b) Scheduled Passenger airlines: A survey by the Civil Aviation Authority shows that the airline industry of the UK in 2009 has handled 7.2% less number of passengers compared to that in the year 2008. This decline in the number of passengers was found to be the biggest in airport records of the UK. This highlights the impact of recession on the airlines industry (Civil Aviation Authority, 2010). In 2009, near about 20 million passengers in the UK took domestic flights. This represents a decline of 1.9 million passengers when compared to 2008. Also, there was a fall in the number of passengers (5 million), compared to that in 2008 (24 million). Therefore, fall in the number of scheduled passenger airlines during the recession implies that with lower incomes, passengers cannot afford flight tickets. The air travel becomes a luxury good for the passengers during the period of recession as is clearly visible from the figure above (figure 4). Income elasticity of demand for airlines becomes highly elastic. 3. Impact of cheaper air fares on passengers after a drop in oil price The number of passengers buying air tickets largely depends on the price elasticity of demand for airlines. It is referred to as the elasticity that is used to measure responsiveness of quantity demanded of a good with respect to change in its price. Mathematically, it is calculated by taking the ratio of percentage change in quantity demanded to the percentage in price of the good. Price elasticity of demand = % change in quantity demanded / % change in price From an article in the Guardian (2015), it has been found that a high price of air tickets reflect the fall in the price of oil. It has been observed that with a drop in oil price, the airline sector has been increasing air fares. Oil acts as a fuel for the airline sector. Thus, with the fall in the price of fuel, the airline industry is raising the price of air tickets to generate more revenue. This is because; drop in oil price leads to higher electricity bills. To safeguard against the climbing costs of fuel, majority of the airlines use hedging strategies to lock prices. Therefore, the passengers do not get the benefit of cheaper oil price (Graham, 2000). Also, the airline industry has to make higher expenses for its operation. They have to make various investments for new plans. This makes them raise the price of air tickets to earn more profit. A major reason for the increase in air fare is the fall in competition made by the industry mergers. However, with higher air fare, the number of passengers goes down and there is a fall in revenue of the airline industry. There occurs lower percentage change in quantity demanded of air tickets as well as a rise in air fare. Thus, this makes the price elasticity of demand for air tickets to fall. Summary From the first section of the paper, it is found that the major two factors that determine the demand for air transport in the UK are change in air fares and income level of the people. The demand for air travel increases with the fall in air fare and rise in income level of the people. In the second section of the paper, it is observed that during the recession period, there was a fall in the passenger traffic in the UK economy. This is because the income level of the people goes down during recession and people have less money to afford air tickets. The demand for air transport becomes highly income elastic during the recession. Finally, in the third section, it has been found that despite of a fall in oil price, the air fares are kept high by the airline industry to earn more profit. However, due to rise in the price of air fare, the quantity demanded for air tickets go down and the revenue of the industry falls. This leads to a decline in the price elasticity of demand for air tickets. Reference List Begg, D. and Ward D., 2013. Economics for Business. 4th ed. New Jersey: Mcgraw-Hill. Civil Aviation Authority, 2010. CAA Statistics show last years fall in passenger numbers was biggest since the second world war. [Online] Available at [Accessed 5 November 2015]. Graham, A., 2000. Demand for leisure air travel and limits to growth. Journal of Air Transport Management, 6(2), pp. 109-118. Njegovan, N., 2006. Elasticities of demand for leisure air travel: A system modelling approach. Journal of Air Transport Management, 12(1), pp. 33-39. Palmer, A. and Hartley B., 2011. The Business Environment. 7th ed. New Jersey: McGraw-Hill. Sloman, J. and Jones E., 2014. Economics and the Business Environment. 4th ed. New Jersey: FT Prentice Hall. Sloman J., Hinde, K. and Garratt., 2013. Economics for Business. 6th ed. London: Pearson. Worthington I. et al., 2005. Economics for Business. New Jersey: FT Prentice Hall. Read More