JC2 H1 Economics MBT Practice Questions MJC 2014

JC1 Tutorial WB P.7-9: The Growth of Air Travel (Part a-c)

(a) Using Figure 1:
(i) summarise the trends in international air passenger growth 2000-2004. [2]

There was no clear trend in international air passenger growth as it showed
considerable fluctuations within the period. (2m)
OR
Overall there was an increase in international air passenger growth from 2000 2004
(1m).
Refinement (Any 1 - 1m):
However in 2001, international air passenger growth registered a negative
growth of 1%
Highest growth in 2004 of 15.6%.
Growth in 2004 was 1.7 times that of 2000.
(ii) compare these trends with the forecast trends for 2005-2009. [2]

Forecast growth for 2005-2009 was less volatile than the actual growth in 2000-2004.
Forecast growth for 2005-2009 decreased over time, whereas growth for 2000-2004
increased.
Forecast growth for 2005 2009 decreased steadily while actual growth fell and then
rose from 2000-2004.
[Any 2 comparative statements 2m]


b) With the help of a supply and demand diagram, explain the likely impact of both
global economic growth and the entry of low-cost airlines on the market for
international air passenger travel. [6]

Global economic growth increase DD for air passenger travel (1m)
With growth occurring around the world (either point below):
1) Trade and business between countries have been growing increase need for business
travel rise in demand for international air passenger travel.
2) Generally consumers around the world have rising incomes increase purchasing power
rise in the demand for international air passenger travel for leisure travel (assuming
normal goods).

Entry of numerous low-cost airlines increase SS (1m)
Increase in number of airline companies in the market for international air passenger travel
also means there are more producers willing and able to produce at every price increase in
supply from S to S1.

Impact on market + diagram (2+1m):
Analysis: Initial equilibrium is at E1 where price is P1 and quantity is Q1. Due to the
rightward shifts in DD & SS, new equilibrium is at E2 where price has increased from P1 to
P2 while quantity has increased from Q1 to Q2.

JC2 H1 Economics MBT Practice Questions MJC 2014

Evaluation (1m): Though there is a definite increase in equilibrium quantity, the overall
change in price depends on the extent of increase of demand and supply.

Increase in global demand of international air travel is likely to be more impactful than the
increase in supply as air travel is a luxury which registers high YED value while the extent of
the increase in the supply of international air travel is constrained by higher oil prices
(suggested in Extract 1) that increases unit COP. Hence increase in demand is likely to be
larger than the increase in supply, causing the price to eventually increase.


(c) (i) What is meant by price elasticity of demand? [2]

Price elasticity of demand measures the degree of responsiveness of quantity
demanded of a good to a change in the price of the good itself, ceteris paribus (1m).

Formula (1m)
Price elasticity of demand for good A = % in quantity demanded of good A (divided
by the) % in the price of good A

(ii) How far does the concept of price elasticity of demand help to explain the
success of low-cost airlines such as AirAsia, Virgin Blue and Tiger
Airways? [6]

Explaining Success & linkage to PED [1+ 3m]: Must come to a conclusion that
PED is greater than 1, strategy is price competition. Draw appropriate diagram to
illustrate increase in TR (fall in price leads to increase in TR increase in profits)
Price
Quantity of
Air Tickets
0
P1
P2
Q1
D1
D2
S1
S2
Q2
E1
E2
JC2 H1 Economics MBT Practice Questions MJC 2014

Objective of the firm is to increase total revenue so as to increase profits. Success as
mentioned in the extract in this case would be seen as experiencing high revenue and
thus profits for the low-cost airlines, accounting for its survival alongside the
established major players. Price elasticity of demand is used by firms to determine its
pricing strategy to increase total revenue and hence profits.

The demand for low-cost air travel is relatively price elastic; as there are relatively
more substitutes available for low-cost airlines services. Low-cost airlines generally
cater to short haul travels with alternative modes of transport such as coach or ferry
service. Thus passengers who wish to travel to near-distanced destinations have more
choices.

This concept has enabled low-cost airlines to experience an increase in their total
revenue when they lower prices as suggested in Extract 2 where low-cost airlines
undercut prices at major airlines by packing in more seats and cutting in-flight
services. As unit cost of production decreases for these airlines, the supply of air
travel increases from S1 to S2, leading to a decrease in the price of air tickets from P1
to P2. With demand being price elastic, the quantity demanded for air travel will
increase by more than proportionately. This increases budget airlines total revenue
from 0P1E1Q1 to 0P2E2Q2, enabling low-cost airlines to maintain their profitability,
thus contributing to their success.



Consider how far (1m for other factors & 1m for a judgment on how far):
High revenue and low cost structure allows low cost carriers like Virgin Blue to earn
sufficient profits to survive in the airline market. However, there are other factors that could
contribute to their success too. For example, the extent to which PED can explain the success
is limited by the violation of the ceteris paribus assumption. Rising affluence of consumers
increase demand for air travel, including low cost airlines increase revenue. Hence
YED also has a part in explaining its success. Thus to attribute the success of low-cost
airlines solely to the concept of PED would not be realistic. Hence PED is useful only to a
certain extent.
D
1
Qty of Air Tickets
Price
P
Q
1
Q2
S2
S1
P
0
E
E1