When the issue of "supply and demand" is associated with the aviation industry, there seems to be more of a supply than a demand

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E-Portfolio Report on United Airlines

ECO 533

February 22, 2005

E-Portfolio Report on United Airlines

Executive Summary

        When the issue of “supply and demand” is associated with the aviation industry, there seems to be more of a supply than a demand.  This excess of supply has bankrupt many airlines like United Airlines (UAL).  United Airlines in the past would show the utility of their service by pampering their business and first class passengers with champagne and steaks.  Complimentary and substitute goods have direct effects on tickets prices whether it is higher fuel costs or other modes of transportation.  The demand for a ticket depends on the ticket being price elastic or price inelastic.  Also, the economic forecast for the airline is a guess at best.  Organizations or companies such as the Congressional Budget Office, the Conference Board, and the Federal Reserve publish economic indicators based on economic trends and historical data.  The Cost Component comes in many different varieties when dealing with the aviation industry.  Higher fuel costs, labor, maintenance, and IT push higher costs.  These and many more issues are what the commercial airline industry in the United States operating as an oligopoly face in today’s market.

Individual Product Pricing Component

When the subject of Economics is brought up, the first thing that usually comes to mind is the law of “Supply and Demand”.  This law illustrates how the consumer will buy more of a product when the price declines and less when the price increases (McConnell et al, 2002).   That very principle holds true for most of the business world.  The Aviation industry is dealing with a major shortage in demand ever since the tragedy of 911.  Currently the airlines are having a hard time making travel a pleasurable experience for the consumer.  With higher security procedures, new check in procedures, and no food being served on flights less than 2 hours; the consumer is feeling little satisfaction.  Competition within the aerospace industry is fierce, mainly because of the number of airlines offering the same product. Along with the issues already discussed, there are many more issues that affect the demand and the price of the service the airlines are offering.

        There are many airlines competing for the same customer, and they all try to offer goods and services that provide utility.   Utility is something that provides pleasure or satisfaction to the consumer (McConnell et al, 2002).  United Airlines is known in the past for catering to the business man.  On long international and domestic flights, United would provide utility in the form of expensive champagne and exotic foods.  By spoiling the business and first class passenger, United would fulfill the needs and expectations of the consumer.  Now a days, utility is giving the consumer the least amount of hassle while in the airport, and providing the cheapest fare. Utility is subjective, so it is difficult to quantify.  Champagne and thick steaks may have great utility to someone who is affluent or a business traveler but little utility to someone who is going on vacation and sits in coach.  In order to get an idea of the amount of satisfaction from the consumer, economists use a total and marginal utility scale.

        Total utility is the total amount of satisfaction or pleasure the consumer derives after receiving a specific amount of service (McConnell et al, 2002).  The measure is broken down in units and placed on a determined number scale.  Marginal utility is the extra satisfaction the consumer realizes when the scale of total utility has reached the top and is increased by one unit (McConnell et al, 2002).  Both scales are dependent on each other.  As the frequent flier boards more flights, the total utility will increase, but at a diminishing rate because the pleasure and satisfaction is not as great as the previous flight.  Ultimately, the frequent fliers total utility will maximize at a certain level then begin to decline.   Therefore the marginal utility declines each time the frequent flier takes a flight and is at zero on the scale when total utility is at its maximum.  Basically, the more the frequent flier takes a trip, the less exciting it becomes and total utility raises at a smaller increment each flight.  As a result, the marginal utility decreases at the same increment, where it is the greatest at the first flight, and lowest on the last flight.  The frequent flier may then choose to try a different carrier to bring his marginal utility back up.

        United Airlines, like all other airlines have many factors that determine the price of their service.  Complementary goods are two products, for which an increase or fall in  for one leads to an increase or fall in demand for the other (Economist).  In the case of United airlines, the increase in the price of fuel will result in an increase in the price of tickets, thus lowering the demand for flight.  As a result the rising fuel cost and higher ticket prices are complements because they are jointly demanded.  If the price of a ticket gets too expensive for the consumer, then a substitute good may be used.  Substitute goods are goods for which an increase or fall in  for one leads to a fall (or increase) in demand for the other (Economist).  In the case of United Airlines, the increasing costs of tickets may force the demand for other transportation methods to increase; (bus, train, car, etc...).  All consumers have a different responsiveness to a price change.

        Price changes may have many different results for the company.  The best-case scenario would be no change, or a rise in demand with an increase in price.  This only happens in rare situations.  To determine how a price change will affect the company, United must first determine if the demand for their product is price elastic or price inelastic.  If the price is elastic, then the price change will cause a large change in the quantity demanded (McConnell et al, 2002).  In essence, if United had a high price of elasticity of demand, a ticket price increase would result in a revenue decrease since the revenue lost from the resulting decrease in tickets sold is more than revenue gained from the price increase.   Conversely, the price is said to be relatively inelastic if a price change will cause less of a change in quantity demanded (McConnell et al, 2002).  If United has a ticket price that is inelastic then the price increase of the ticket would result in a revenue increase since the revenue lost by the relatively small decrease in ticket prices is less than the revenue gained from the higher price.  Unfortunately for United Airlines, their ticket prices a very elastic, meaning an increase in ticket price would result in revenue lost situation.  The emergence of the low cost carrier really affects the demand for the higher ticket price that United Airlines would like to market.

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        The consumer demand for a specific product will vary as the price for the product changes.  The demand for a ticket to fly with United Airlines varies with price while keeping all other factors constant.  Some issues that affect consumer demand and the price of a ticket include; the individuals’ budget, meaning the individual can only afford a certain amount of money for a ticket.  Next is the substitution effect, where the consumer buys what is cheaper.  There is rational behavior used by the consumer, who tries to use their money to get the most amount of satisfaction, or the ...

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