There appears to be an inconsistency between the size of price elasticities estimated for the air transport industry and those estimated for the overall travel and tourism industry. Yet everyone in the travel and tourism industries knows they are dealing with very price sensitive customers, and that changing prices does produce a large demand response. There are two main explanations:
•Substitution of components within an overall package. In situations where one component of a package can be substituted for an adequate alternative then the price elasticity for that component can be much higher than suggested by the price elasticity of the overall package. For example, changes in an air travel price could result in the passenger changing to a different airline, route or another transport mode while still undertaking a similar journey. Therefore, the elasticity for the overall journey cannot be inferred from the air travel price elasticity and must instead be estimated on a separate basis.
•A “two-stage” decision-making process. Travellers are induced to select a destination based on the level of air travel price offered, and having booked the flight then consider the other costs associated with the travel (e.g. booking a low-fare air ticket and then making a separate decision on hotels, etc). In this case, the overall decision to travel is more sensitive to changes in the initial air travel price.
Therefore, passengers can be relatively more sensitive to the cost of the air travel price, even though it is only one component within the overall cost of travel. Air travel itself is a derived demand, based on the demand for passengers to travel to another location for business or leisure purposes. The other components of the journey cost are derived from the decision to travel and are essentially complementary goods to air travel (i.e. they have a cross-price elasticity to air travel prices of less than zero).
Level of Aggregation
The appropriate value of a demand elasticity will vary in accordance to the context in which they are considered. In particular, the scope of the price change and the demand impact being assessed will have a key influence on its value, with demand typically being more sensitive to price when a greater amount of substitutes are available.