Demand, Supply, and Elasticities at British Airways

A recent New York Times article (“British Airways Tries Premium New York Flights”) gives insights into how demand, supply, and elasticities work together in the market.

Let’s first consider the demand for flights. On routes where alternatives exist, such as the London-Paris route which competes with the Eurostar, demand is relatively elastic. In fact, demand for flights on this route has decreased to the point that British Airways is considering closing the route. However, most flight routes do not have acceptable alternative methods of travel. Where this is the case, there are two types of customers: leisure travelers for whom demand is relatively elastic (consider the increasingly popular “stay-cations”) and business travelers for whom demand is relatively inelastic. As the article puts it, “there’ll still be bankers flying all over the place.”

Next let’s consider the supply of flights. In the short-run, the supply of flights is relatively inelastic: flights have been scheduled, customers have purchased seats, and British Airways has little leeway to cancel flights. In the long-run, however, British Airways is free to cancel flights and adjust routes in order to maximize their profits. Consider the following quote from the article, “This is an airline that really has to bite the bullet on short-haul, looking long and hard at what it’s costing and whether they can ever get a decent margin out of it. Some U.K. and European routes have a very limited future.” This is a classic case of a relatively inelastic supply in the short-run and a very elastic supply in the long-run.

So how does a company like British Airways use elasticities of demand and supply to try to remain profitable? British Airways has chosen to begin a business-class-only service from London to New York while closing some shorter routes. In effect, they are altering their supply in an effort to cater to the market segment whose demand is most inelastic. Do you think it’s going to work for them?


Adam said...

I liked your observations. I think that their ideas have merit. However, since I don’t know much about that kind of market or industry, it’s hard to tell. If they have a market that is big enough to sustain the business, then it should probably work. If the segment is too small, or if they have alternative means of travel, then they will probably crash and burn. They are taking steps to increase the attractiveness of their business which means they are pointed in the right direction, but perhaps they could differentiate themselves in other ways to increase their revenue. This gets more into strategic management than economics, but using price elasticities will help them along the way.

Dr. Tufte said...

I think Jayden's use of elasticities is excellent. And ... I can confirm that airlines do think in exactly the way described.

Having said that, I don't think you should be fooled into thinking that this is new thinking, or thinking that will "save the airlines". The basic problem is that airlines are a form of passenger transportation, and there has never been a form of passenger transportation that has been able to maintain profitability in the long-run. Think about: stage coaches, ferries, turnpikes, railroads, passenger shipping, subways, buses, and so on. Complementing that is that personal ownership of passenger transportation has almost always been necessary, and it's a losing proposition for most people. This is why car makers spend so much on creating a mystique around driving: they're pushing the idea of psychic income because if you actually toted up the monetary costs you probably wouldn't drive.