The relationship between the price sensitivity at the aggregate market level E and at destination-specific route levels (own-price elasticity Eii and cross-price elasticity Eij) is described in a study carried out by the UK CAA13 as:
E = Σi Si (ΣjEij)
where Si is the traffic share of destination i.
An hypothetical example will help illustrate the implications for policy. Assume there are just two routes for a national market, A and B with own-price elasticities EA = -1.4 and EB = -1.4. Own-price elasticities indicate for instance that a 10% rise in air fares just on route A would lead to a 14% decline in passengers on that route. Cross-price elasticities are, say, EAB = 0.6 and EBA = 0.6. This means that, for instance, the 10% rise in air fares just on route A would, as well as causing a 14% decline in passengers on route A, boost passengers on route B by 6%. Therefore, a price rise does not just suppress demand, it diverts it to another route. This clearly affects the overall net impact.
If both routes have a market share Si of 50% then the weighted average national own-price price elasticity is -1.4. This might suggest that a policy that raises the cost of air travel nationwide by 10% would reduce air travel volumes by 14%. However, that conclusion would be wrong. To see why, using the expression for aggregate elasticity above:
E = SA(EA + EAB) + SB(EB + EBA)= 0.5(-1.4 + 0.6) + 0.5(-1.4 + 0.6) = -0.8
This shows that the aggregate price elasticity is not -1.4 but -0.8 i.e. the reduction in passengers to a 10% rise in air fares is not 14% but 8%. This is a relatively inelastic or price insensitive response. Table A1 uses the same example to work through the effects
The relationship between the price sensitivity at the aggregate market level E and at destination-specific route levels (own-price elasticity Eii and cross-price elasticity Eij) is described in a study carried out by the UK CAA13 as:E = Σi Si (ΣjEij)where Si is the traffic share of destination i.An hypothetical example will help illustrate the implications for policy. Assume there are just two routes for a national market, A and B with own-price elasticities EA = -1.4 and EB = -1.4. Own-price elasticities indicate for instance that a 10% rise in air fares just on route A would lead to a 14% decline in passengers on that route. Cross-price elasticities are, say, EAB = 0.6 and EBA = 0.6. This means that, for instance, the 10% rise in air fares just on route A would, as well as causing a 14% decline in passengers on route A, boost passengers on route B by 6%. Therefore, a price rise does not just suppress demand, it diverts it to another route. This clearly affects the overall net impact.If both routes have a market share Si of 50% then the weighted average national own-price price elasticity is -1.4. This might suggest that a policy that raises the cost of air travel nationwide by 10% would reduce air travel volumes by 14%. However, that conclusion would be wrong. To see why, using the expression for aggregate elasticity above:E = SA(EA + EAB) + SB(EB + EBA)= 0.5(-1.4 + 0.6) + 0.5(-1.4 + 0.6) = -0.8This shows that the aggregate price elasticity is not -1.4 but -0.8 i.e. the reduction in passengers to a 10% rise in air fares is not 14% but 8%. This is a relatively inelastic or price insensitive response. Table A1 uses the same example to work through the effects
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