Answer to Question #184233 in Economics for Sara

Question

QNO1 

Southwest Airlines is a major carrier based in Texas, and has made a strategy of cutting fares drastically on certain routes with large effects on air traffic in those markets. For example on the Burbank–Oakland route the entry of Southwest into the market caused average fares to fall by 48 per cent and increased market revenue from $21,327,008 to $47,064,782 annually. On the Kansas City–St Louis route, however, the average fare cut in the market when Southwest entered was 70 per cent and market revenue fell from an annual $66,201,553 to $33,101,514.

1 Calculate the PEDs for the Burbank–Oakland and Kansas City–St Louis routes.

2 Explain why the above market elasticities might not apply specifically to Southwest.

3 If Southwest does experience a highly elastic demand on the Burbank–Oakland route, what is the profit implication of this?

4 Explain why the fare reduction on the Kansas City–St Louis route may still be a profitable strategy for Southwest.

Answer 1

1. PED > 1 for the Burbank–Oakland route, so the demand is elastic, and PED < 1 for the Kansas City–St Louis route, so the demand is inelastic.

2. The above market elasticities might not apply specifically to Southwest, because it is elasticity of demand for aircraft transportation, not of supply.

3. If Southwest does experience a highly elastic demand on the Burbank–Oakland route, then the profit will increase.

4. The fare reduction on the Kansas City–St Louis route may still be a profitable strategy for Southwest in the long run.