Question

1. Space Spider Airline is the only airline in Spiderland. The airline has two major groups of passengers – business travelers and vacation travelers. One group of them has its price elasticity of demand at -1.8 and another group has -3.0 respectively.

a. Which group, business travelers or vacation travelers, is more likely having its price elasticity of demand at -3.0? Briefly explain your answer.

b. Which traveler group will be charged a higher fare by Space Spider Airline under price discrimination? Suggest THREE practical ways for Space Spider Airline to identify this group of passengers. Explain your answers briefly.

2. There are many kinds of costs of inflation to a society. Explain THREE such costs of inflation which are relevant to business firms.

3. During the spread of COVID-19, the price of surgical masks skyrocketed. Some people in Hong Kong suggested the government to impose a price ceiling on surgical masks. Explain, in the economic sense, why this might not be a good idea in handling the needs of Hong Kong people

Answer 1

Q1

(a) The price elasticity of demand should be much lower for travelers who are traveling for essential reasons that can not be postponed. These are business travelers. Vacation travelers likely to have a higher elasticity of demand of -3. Business travelers are traveling for work and will do so irrespective of the price unlike vacation people, who can simply postpone the travel if prices are high or travel earlier, and take advantage if prices are low.

(b) Under price discrimination, the Space Spider Airline will charge a higher price for the business travelers because an increase in price (or higher prices in general) leads to a lesser decline in the quantity demanded of airline seats as compared to the vacation travelers. The airlines can identify the two groups through the following:

(i) On the website for airline ticket booking, the airlines can get some inference about the group type by simply asking the passengers the purpose of travel before booking and showing prices.

(ii) The airlines can also use the booking page to ask the passengers whether after booking the flight, the passengers want to be directed to a webpage showing holiday resorts in and around the destination area. If travelers opt-in, they are likely to be vacation travelers.

(iii) The airlines can gather some understanding of the two groups by understanding the number of people traveling and their respective age groups. If the group includes both children and elderly people, they are most likely to be vacation travelers. Slightly smaller groups of working-age men and women are more likely to be business groups