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Economic Analysis of the Airline Industry

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The airline industry is one that is both costly and necessary to the economy. Costly because of the funding provided by the government, recent layoffs; which has a hand in rising inflation, dealing with negative externalities and high security risks; necessary because the ease and speed of air travel is needed to keep countries productive and competitive. It is a key component to the economy. Many businesses rely on air transportation as well as consumers and individuals employed within the industry. Without this form of accelerated transportation, production necessary for economic growth would decelerate. Businesses would not be able to meet supply demands. The slump in the demand for airline travel has been caused by events such as terrorist activity; war related issues as well as infectious disease outbreaks such as SARS (Leary, 2003).

Even before these issues, the airline industry faced financial struggles after the enactment of de-regulation which caused an increase in competition. “The Airline Deregulation Act enacted by Congress in 1978, has allowed the U.S. airline industry to become the primary intercity mass transportation system in this country (Duke & Torres, 2005)” Deregulation eliminated governmental interference in setting the price of fares in the industry. Labor Supply and Demand

Wages in the airline industry have been an issue for many years because they continue to fluctuate up and down depending on current events such as bankruptcies, increased competition, a decline in air travel and terrorist activity. Higher wages in the airline industry could be attributed to the presence of a Union. When unions are present, representatives are able to negotiate higher wages for employees as well has initiate strikes and withhold labor until a desirable wage is offered. Because the industry is currently turning a profit, due to an increase in the demand for airline travel, union leaders are in a better position to negotiate better wages for airline employees.

The unions are only able to do so much. Eventually, wages of airline workers will and have been cut. If an airline is bankrupt, the goal of the airline is to save the business and do what is in the best interest of share holders, at the workers expense. Benefits have been cut as well.

Union members argue that the airline industry is using the events of 9/11 as the prime factor creating wage inequality. It is using the crisis as an excuse to cut jobs and lower wages, while accepting funding from the government to dig them out of a debt that they were in before any tragedies following 9/11 occurred. An increase in the demand and supply for airline personnel has affected the equilibrium wage. Air travel is on the rise, so the industry offers higher wages to attract quality applicants. Because wages have slightly increased, the labor supply and demand curve shifted to the right. Supply and Demand

Supply and demand can be measured by the market for air travel, that is, supply and demand can be measured based on how and what air travel is used for such as business or leisure. Use of air travel is also impacted by the distance that needs to be traveled. The demand for air travel should be slightly higher for people needing to travel longer distances.

After September 2001, there was a long stretch in which the supply exceeded the demand for air travel, causing a surplus. To compensate for lack of demand, prices were cut and jobs were eliminated. The idea was to increase the demand for air travel by decreasing fares.

Currently, prices are on the rise again as the demand for air travel increases (Reed, 2006). Consumers feel safer with increased security, government intervention and enhanced safety precautions. Also, as prices for fares increase, the supply curve slopes upward. Price Elasticity and Income Elasticity of Demand

The price elasticity of demand for the Airline industry is considered to be elastic. This is because air travel is not the only means of transportation. A person would like the speed and convenience of travel by air, but other transportation alternatives exist. Air travel is both a luxury and a necessity depending on the purpose of its use. For the purpose of vacationing or visiting friends and family, air travel could be considered a luxury, but for the individual or company who relies on the speed of air travel to complete business transactions, it would be considered a necessity. The supply and demand of air travel is impacted by several factors. Air travel is a normal good. The demand for air travel can diminish slightly because there are other means of safer transportation available. The demand can also decrease if it becomes too unaffordable. Consumers with a higher income are able to spend more time vacationing with the use of air transportation. Air travel can be substituted with other forms of transportation if the income of the consumer decreases.

The price elasticity of supply for the Airline industry however, is inelastic because even with the shifts in demand for air travel, which were caused by events such as the 9/11 attacks and high gasoline prices, the rates and fares for air travel are able to be set without being effected by those events.

The airline industry provides a transportation resource as a public service. There is minimal competition from smaller flight providers and even less since 2001. An air port and the services provided within the airline industry could be considered both a public good and a natural monopoly because it is non- rival, and excludable. A person may be prohibited from using an airlines services under certain circumstances, such as being restricted or unable to book a flight, but it is not rival because its use by one person does not prevent others from using it.

Positive and Negative Externalities of the Airline Industry
In the airline industry, transactions between customers and the airline cause both negative and positive externalities. While negative externalities include things such as air pollution, air traffic congestion, noise pollution, terrorist threats and a decrease in the property value of surrounding areas, there is also the positive externality of an increase in economic growth with the use airline travel. Negative Externalities

One of the most publicized negative externalities in the airline industry has been caused by the issue of terrorist attacks. The economy has been affected by a decrease in air travel due to these events. Because of the decrease in air travel, there were many jobs lost because of slipping revenues. The revenues that were lost by the tourism industry were over 50 billion dollars: a huge economic impact. In order to combat the economic impact of terrorism, efforts have been made by the government to increase airline security. Efforts have also been made by the airlines by offering extremely low rates, discounts and the frequent flyer miles program as an incentive. These efforts have helped revive the airline industry, and for the first time since the huge slump in the industry began, it has been able to turn a profit (AFP, 2007).

The economy is impacted by the negative externality of pollution from jet fuel. Governments are searching for ways to decrease this externality by deciding whether or not to tax jet fuel. Taxing jet fuel is a way of internalizing this negative externality. A rise in the cost of jet fuel will affect the economy significantly. Many airlines are already suffering financially with their current operating costs. If the price of jet fuel is increased and taxed, many people believe that it will decrease air travel as well as limit the number of new airlines being developed, decreasing the amount of competition. This will in turn reduce the amount of harmful emissions from heavy air travel which includes carbon dioxide, as well as nitrogen and sulfur dioxides. The emissions that cause pollution adds another economic issue: finding funding to develop ways to combat the effects of air pollution.

Unintentionally, the airline industry affects the quality of life in many ways. The negative externality of decreased property values because of the location of some airports cause many property owners unwanted stress. People are forced to sell their homes for less than the fair market value because of the airline industry. There are also situations where governments take possession of property to expand airports. Negative externalities seem to generate more publicity because they are noticeable and more exposed. The positive externalities are hidden, but have great benefits to third parties and the economy. Positive Externalities

Air travel promotes economic growth. It helps to stimulate trade, improve productivity and attract investments. There is the added benefit of faster travel time, as well as better efficiency for suppliers and buyers who are able to transport larger amounts of their goods, to a wider amount of destinations: to places unreachable without the help of air travel. Increases in air travel also helps economically through the taxation of the industry by the government. The airline Industry supplies many jobs, and continues to do so as travel conditions become safer and recover from past fears of terrorism. The increase in jobs helps the economy. Increase in air travel also gives the industry the ability to offer lower rates to customers, which also boosts economic conditions. “When the price of a good decreases, the demand for it increases, Mankiw, 2004)”

Many businesses rely on airlines to survive and remain profitable. The business transactions from many companies who utilize air travel do their part to contribute to the economy. Consumer Price Index

The monetary and fiscal policies that the government has development were designed to increase public spending and increase airline travel. These policies include decreasing tax liabilities for businesses and individuals as well as lowering interest rates as an effort to boost consumer spending. Before certain monetary and fiscal policies were developed to combat the recession after the events of 9/11, many airline workers lost jobs and many other consumers stopped spending money for the fear that they too would lose their jobs or some of their benefits. There was also the issue of safety in air travel. Before monetary and fiscal policies were implemented, airlines that recently had to release a lot of workers, were able to rehire a small percentage of workers and increase security because of financial help from the government, and decreased flight rates. Lowering flight rates has proven to be moderately effective for increasing airline travel. Employment rates were able to increase slightly, but the growth rate has had an opposite effect. Before financial difficulty increased in the airline industry after 9/11, there were a number of new entrants into the airline industry that were becoming more competitive. Some of the policies make it less desirable for new entries into the airline industry, such as a huge tax on jet fuel. Conclusion

No other industry has had a larger economic impact than the Airline Industry. Its influence stretches from contributing to increased unemployment rates, an increase in inflation: the airline has lost over $40 billion dollars since the 9/11 attacks (Wallace, 2007), changes in monetary and fiscal policies and the introduction of negative externalities, mainly air pollution. While the negative externalities are widely publicized and heavily debated, the not so apparent positive externalities appear to be the ones that have a larger impact on the economy. The failures in the airline industry have caused changes to many markets, consumers and other areas. Even the U.S. monetary system is affected by the success or failure of the airline industry. The job supply not only decreased in the airline industry, but in other areas that rely on air travel to maintain a thriving business. Airlines provide a means for many businesses to operate and trade with other countries. Major sources of income in the United States were halted when problems worsened in the airline industry. The airline industry affects the economy more than any other because almost all other main industries rely on the Transportation industry. The airline industry may very well be our countries economic life support.


AFP, (2007) Airline industry slowly emerging from financial turmoil
http://www.keepmedia.com/pubs/AFP/2007/01/23/2607505?cl=true&pbl=163 Air
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Retrieved, February 9, 2007 from http://www.tinbergen.nl/discussionpapers/97031.pdf Wallace, (2007), SeattlePi.com, Airline industry expects to turn profit, Retrieved, March 10, 2007 from, http://seattlepi.nwsource.com/business/306929_iata10.html

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