“After the recession caused by the Sept 11 terrorist attacks in

Document Sample
“After the recession caused by the Sept 11 terrorist attacks in Powered By Docstoc
					“After the recession caused by the Sept 11 terrorist attacks in 2001, most major
airline carriers in the United States are now faced with rising fuel costs,
expensive labour and tough competition from low-cost carriers. All these led to some
major airline carriers suffering huge losses.”

                                             Adapted from The Straits Times, 15 September 2004

Using demand and supply analysis, explain how the factors mentioned above affected
the market for major airline carriers. [10]

With the rise in fuel prices, it will have an adverse impact on the major airline carriers as fuel prices
constitute roughly 10-12% of the airline’s operating expense. Every penny increase in the price of fuel
can cost an airline industry over a hundred million dollars a year. (In fact, fuel prices sometimes
indirectly lead to major economic recessions as the industry is inextricably tied to the overall economy.)
With the rising fuel costs, profit-driven industries will try to cut down on the gallons of fuel purchased
for the airline carriers in order to keep the cost of production low. This is illustrated in the diagram
below, with the supply curve shifting to the left.

In theory, an increase in the number of producers in a particular market increases the supply, causing
the supply curve to shift rightward. This is because more can be supplied at the prevailing market price.
With more competition for airline carriers as low-cost carriers entering the market, the market supply
for flight tickets increase and is shown by a rightward shift of the supply curve from SS0 to SS1. Quantity
supplied exceeds the quantity demanded at the original price, P1 resulting in a surplus. Hence, there is a
downward pressure on price from P1 to P2. As price falls, quantity demanded will increase along the
demand curve DD1 and quantity supplied falls along the supply curve SS1. At the next equilibrium point,
we see that the cost of flight tickets dropped due to more competition in the market, and the new price
of flight tickets stand at the new price P2. All these are shown in the following diagram.
As major airline carriers are faced with expensive labour, it would lead to a shortage of supply in the
market for airline carriers. This is due to the increased wages that these major airline carriers would
have to pay for labour, meaning increasing costs of production, as companies would then have to pay
more to employ workers. Rather than spending more money while the economy is down, and in
addition to facing other challenges such as rising fuel costs and tough competition from low-costs
carriers, major airline carriers would rather reduce the supply of their services due to increase costs of
services. Hence the supply curve, in the diagram as follows, shifts leftward similar to the case of rising
fuel costs.
In conclusion, the recession caused by the September 11 terrorist attacks has caused the fuel and labour
costs to rise. This results in a raise in the cost of production for the airline companies, therefore
decreasing their supply. This leads to an increase in the prices of air tickets and therefore there will be a
decrease in demand as well. In addition, major airlines face tough competition from low cost carriers
which are substitute goods of them. All three factors will result in losses for the major airlines.

                                                                                    Done by: Rachael Wang

                                                                                                 Adelyn Foo

                                                                                               Amanda Lam

                                                                                                    Yang Jie

                                                                                                    Joan Toh

                                                                                                   Of 11S7K

Shared By: