Question

In the spring of 2003, the international community experienced the outbreak of Severe Acute Respiratory Syndrome (SARS), a contagious and frequently deadly disease that appears to have originated in China. Concern over catching this disease greatly discouraged travel to and within China.

a. .With the aid of the graph provided, explain the effect of this outbreak on the market for airline travel within China (where, in fact, there are numerous competing airlines).

b. Interested in protecting Chinese airlines from the effects of these changes, in July of that same year the government of China considered imposing a price floor for all airline travel within China. Suppose the government sets the price floor at the pre-SARS equilibrium price. Show in your graph and explain what will happen in this market.

c. If the stated objective of this policy is to ensure that revenues for Chinese airlines (from travel within China) will return to pre-SARS levels, will the policy accomplish its goal? Yes No

d.This proposed policy was criticized by the China Daily News, with one reporter predicting a decline in revenues for suppliers, compared to what they would earn with no price floor. This argument is correct. This argument is incorrect. Whether this argument is correct depends on other factors. Explain.

Answer 1

a. The outbreak of SARS will reduce the demand for air travel to China. Since its an airborne disease many would not be in favour of travelling to China or within in, except under exceptional circumstances. This would lead to a leftward shift of the demand curve from D to D1, shown by the arrow in the diagram, the supply being constant , consumers , in fear of getting infected by SARS reduce their preference for airline travel leading to a fall in the market demand for airline travel from Q to Q₁. This reduces the price from P to P₁.

b. Since there are many competing airlines in China which may be adversely affected because of the fall in demand for airline travel due to SARS ,the government may legally fix a minimum price called the “floor price” to provide support for the producers to enable them to get a suitable compensation, if not a break even ,as a return for their investment. The government may set the price at P, as shown in the diagram, which is the pre-SARS equilibrium level. This may act as a booster for airline companies to promote their sales.

c. The policy may not bring in revenues as earlier since the market demand for airline industry is elastic and the consumers may prefer to consume other modes of transport in the wake of SARS.

It may bring back the revenues to the earlier level as the markets may return to normalcy and consumers may prefer air travel as before, since one of the advantages that air travel has over other modes of transport is that it is the fastest way to reach a destination

d. The report of the Chinese news daily regarding the decline of the revenues could be correct since demand for airline travel has other close substitutes like railways, waterways and roadways. Consumers, in their concern for safety may prefer travelling by other modes of transport avoiding airlines thus this may lead to fall in revenues for airline industry.

However, the report may not be correct and the revenues may not decline as the government set a floor price at the pre-SARS level. There are other factors like preferences of the consumers aggressive sales policies by airline firms, revival generated positivity may be factors that could influence the growth of airlines industry again.