Question

Suppose that you are the CEO of a discount airline that caters to students on tight budgets who want to travel to warm locations when the weather gets cold. Currently, your airline flies small regional jets from Columbus to 6 cities in Florida; Miami, Tampa, Ft. Myers, Orlando, Ft. Lauderdale and Key West. To keep your business model simple and to better compete with other airlines, you charge a flat round-trip airfare to all of these destinations.

As CEO, you are obviously concerned about the impact that the pricing of tickets has to do with demand for air travel, as well as how students’ incomes impact ticket sales. After all, many airlines have gone out of business over the years due to not being able to profitably compete, and the last thing you want to see your airline go under as well.

Therefore, you’ve conducted a study and have the following information at your disposal.

Annual Student Income	Demand for Tickets
5,000	5,000
10,000	8,000
15,000	12,000
20,000	18,000
25,000	25,000
30,000	40,000

Round Trip Airfare	Demand for Tickets
100	75,000
200	55,000
300	40,000
400	30,000
500	24,000
600	20,000

ED = (% change in quantity demanded)

EY = (% change in quantity demanded) (% change in price) (% change in income)

Given the formulas listed above, please answer the following questions:

1. What is the EY when student incomes increase from $20,000 to $25,000?

2. What is the EY when student incomes increase from $10,000 to $15,000?

3. Do students generally consider airline tickets to Florida a normal or inferior good? Briefly explain.

4. Considering your answer in question 3, should your advertising department target students that have higher incomes? Why?

5. What is the ED when RT airfares increase from $200 to $300?

6. What is the ED when RT airfares increase from $300 to $400?

7. What is the ED when RT airfares increase from $400 to $500?

8. Do students generally consider airline tickets to Florida to be elastic or inelastic? Briefly explain.

9. Suppose that airfares are currently $200.Should you raise them to $300? Why? Keep in mind that you are trying to increase your total revenue.

10. Suppose that airfares are currently $400.Should you raise them to $500? Why? Again, keep in mind that you are trying to increase your total revenue

Answer 1

1) E_Y=Percentage change in quantity demanded/Percentage change in price

or, E_Y={(25,000-18,000)/18,000}/{(25,000-20,000)/20,000}

or, E_Y = (7,000/18,000)/(5,000/20,000)

or, E_Y = 1.56

2) E_Y = Percentage change in quantity demanded/Percentage change in price

or, E_Y={(12,000-8,000)/8,000}/{(15,000-10,000)/10,000}

or, E_Y = (4,000/8,000)/(5,000/10,000)

or, E_Y = 1

3) As income rises, demand for air ticket also rises. This means income elasticity of demand is positive. Thus, airline tickets to Florida is a normal good.

4) As income elasticity of demand increases with increase in income, advertising may result in higher increase in quantity demanded for larger income groups. Thus, advertising department must target students in higher income groups.

5) E_D = Percentage change in quantity demanded/Percentage change in price

or, E_D = {(40,000-55,000)/55,000}/{(300-200)/200}

or, E_D = (-15,000/55,000)/(100/200)

or, E_D = -0.55

6) E_D = Percentage change in quantity demanded/Percentage change in price

or, E_D = {(30,000-40,000)/40,000}/{(400-300)/300}

or, E_D = (-10,000/40,000)/(100/300)

or, E_D = -0.75

7) E_D = Percentage change in quantity demanded/Percentage change in price

or, E_D = {(24,000-30,000)/30,000}/{(500-400)/400}

or, E_D = (-6,000/30,000)/(100/400)

or, E_D = -0.8

8) Demand for airline tickets to Florida is inelastic as price elasticity of demand is less than zero, i.e, there is a smaller change in quantity demanded with change in price.

9) As the demand for airline tickets is inelastic, total revenue increases as price increases from $200 to $300. Thus, raising price from $200 to $300 is profitable.

10) Total revenue at price $400 is $120,000(400*30,000) while total revenue at price $500 is $120,000 (500*24,000). Thus, it is not profitable to increase price from $400 to $500 as total revenue remains the same.