a. Suppose that a 20 percent increase in the price of jet fuel causes a 5...

a. Suppose that a 20 percent increase in the price of jet fuel causes a 5 percent decrease in the consumption of jet fuel. What is the price elasticity of demand and do you think this is a realistic number? Explain why (hint: discuss the determinants of elasticity).

b. In a recent fare war, WestJet reduced the price of its one-way airfare from Vancouver to Winnipeg from $198 to $138 to match Air Canada. WestJet matched the fare reluctantly, saying it would cost the company millions of dollars in revenue for those tickets to be sold for less. Air Canada, on the other hand, believed the fare cut would increase its revenue even if rival airlines matched the lower fares. What different assumptions about the underlying price elasticity of demand for airline tickets on that route did each airline believe true?

Solutions

Expert Solution

1. Elasticity can be calculated using the following formula

Price Elasticity of demand = 0.25 (Inelastic).

Yes I believe on the numbers. Travelling through air is fast and quick and currently it is the fastest medium of transport, that is no close substitute is available in the market. Therefore A significant increase in the price of jet fuel won't reduce the quantity demanded. So, we can say jet fuel is inelastic due to non availability of close substitute.

2. West jet reduced the price and feels that reduction in price would result in reduction of total revenue. Therefore, we can say they believe that the price elasticity of demand is price inelastic a reduction in price will reduce the total revenue.

Air Canada feels reduction in price will increase the Total Revenue. According to this belief they consider the price elasticity of demand to be Elastic. As we know in case of Elastic demand lower the price higher the revenue.

West Jet consider price elasticity of demand to be inelastic.

Air Canada consider price elasticity of demand to be Elastic.

Please contact if having any query thank you.

Rahul Sunny answered 1 year ago

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