Demand Elasticities in Airline Business

In economics, elasticity measures the response or sensitivity of one economic variable to the change in another economic variable. Demand elasticity measures the change in quantify demanded of a particular good or service as result of changes to other economic variables, such as the price of the that good or service, the price of competing or complimentary goods/services, income levels, taxes,

Demand elasticity at Different Levels: 

Fare Class Level: Travellers  choose between different fare classes (first class, business class, full economy, discount economy, etc.) on particularly airlines. At this level, the elasticities are arguably highest. Travellers can easily switch between fare-class levels, airlines, use of another mode of travel (in some cases), or simply chose to not travel (i.e., other activities act as a substitute for air travel). For example, in response to an increase in the full economy fare on a given airline, the traveller can respond by booking a discount economy fare on the same airline, or book with another airline, or travel by another mode.

Carrier Level: The elasticities at this level reflect the overall demand curve facing each air carrier on a given route. In situations where there are a number of air carriers serving the route, the demand elasticity faced by each carrier is likely to be fairly high – if an air carrier increases it fare unilaterally, it is likely to lose passengers to other carriers operating on that route

Route / Market Level: At the route or market level the elasticity response might be expected to be generally lower than at the fare class or carrier level. Travellers faced with a fare increase on all carriers serving a route (e.g., due to an increase in airport fees and charges), have fewer options for substitution. However, they can chose to travel on an alternative route or not travel

National Level: At the national level, fare elasticities would be expected to be lower still, as travellers have fewer options for avoiding the fare increase. For example, if a national government imposed a new or increased tax on aviation, travellers could only avoid this increase by using another mode (which may not always be possible), or not travelling.

Supra-National Level: This represents a change in prices that occurs at a regional level across several countries. For example, an aviation tax imposed on all member states of the European Union. In this
case, the elasticity is expected to be even lower, as the options for avoiding the price increase are even further reduced.

Credits: IATA

Demand Analysis of Pakistani Airline industry

Air Traffic Size vs Population Size: There is a strong correlation between per capita income of a country and the size of its passenger traffic. In developed countries passenger traffic is 100 – 300 % of their population size (USA, Canada, UK, France, Germany, Australia, Japan etc). Annual Air Traffic in China is about 33% of its population and in India it is about 20% its population though air traffic growth on its domestic routes is the highest in the world (21%). This unusual growth level reflects Government’s decision to remove unnecessary restrictions in air transport sector and encouraging private sector to in airlines and airports including foreign investments. This had to be done against the pressures of Government owned Indian Airlines. Extra ordinary growth in demand on domestic sector is also due to ever increasing size of its middle class, which stands at about 400 million people, and stiff price competition among the airlines, making air travel within the reach of middle class.

Currently Pakistan has about 16 million annual passenger traffic, both domestic and international passenger traffic put together. Given the population of about 200 million, annual passenger traffic is only about 8% of the population. Broken down to domestic and international percentages, it is about 3% on domestic routes and about 5% on international routes which is mainly expats. Annual growth in traffic is about 4%. International traffic in Pakistan mainly consists of overseas Pakistanis travelling to/from Pakistan that too only once in two or three years on the average. Inward tourism, in the true definition the term, is negligible, whereas in other countries it forms a sizable portion of the total international traffic. This should not be surprising given the internal security situation,for last two or three decades. Growth in air travel is also linked with growth in national economy. Growth in domestic air traffic has been negative from 2007-2008 onward. it has recently leveled to about 1% per annum, compare it with Indian 21%.

The Interaction between Own-Price and Cross-Price Elasticities

Demand Elasticity at Class Level: Opportunities for the passengers to switch from one class of fare level to another as a result of fare hike by an airline for particular fare class (i.e. economy) are negligible on domestic routes in comparison to international routes. The reasons are as under:

  • Domestic Routes: Two of the three competing airlines operate all economy class. The third one PIA also has all economy configuration on its A320 and ATRs, though B-777s & A310s do have upto three classes of seating arrangements. But these aircraft primarily operate long haul international routes. Hence the opportunity to switch to higher class or lower class seats does not exist. The opportunity to switch the airline altogether does exist on trunk routes i.e. Karachi-Lahore, Karachi-Islamabad. This opportunity also exists on medium level routes like Peshawar, Sialkot, Multan, Faisalabad and Quetta albeit to a limited extent because of fewer weekly frequencies floated by each airline.  No opportunity, however, is available to passengers to either to switch the fare class or the airline on socio-economic routes such as Chitral, Gilgit, Skardu, Gwadar, Turbat, Panjgur etc. This is because only Government owned airline PIA operates on these routes. Ironically suitable substitutes (road/rail) are also not available on these routes, some for geographical reasons and others for security reasons.
  • International Routes: An increase in economy class fare may result in switching to ‘economy plus’ or business class fare for the passengers travelling by PIA B777 or A310 on long haul routes. Alternatively these passengers can switch over to foreign airlines operating indirectly on long haul routes from Pakistan. On short to medium routes primarily Middle Eastern routes the opportunity to switch over to national and international airlines is great. Hence ‘Fare Class’ elasticity is fairly high on international routes.

At the airline level: A unilateral increase in the travel price of one particular airline on a route can increase the demand for other carriers on the route and the demand for connecting alternatives (IATA).

At the route level: An increase in the price of travel from London Heathrow to Paris CDG can increase the demand for travel on London Gatwick to Paris CDG or London Heathrow to Paris Orly (IATA). In Pakistan, however, there is only one airport in one city. Lahore does compete Sialkot and Faisalabad to some extent but not to a large extent because of lessor opportunities for the passengers to find the desired international connections.

At the national level: An increase in the price of air travel to/from a given country may increase demand for air travel to/from other countries (IATA). This phenomenon holds good for tourist traffic and it relevant in case Pakistan for outward tourism. Inward tourism is negligible for security reasons.

At all levels of aggregation: There may exist cross elasticity effects with other modes of transport. An increase in the price of air travel may increase demand for ground transportation and vice versa (IATA).

There may also be cross elasticity effects between air travel and other leisure or consumption activities. In some cases it may not exist at all (e.g. there is generally no substitute for air travel on long-haul
routes). IATA