The Changing Price Elasticity of Demand for Domestic Airline Travel

Consumers make economic decisions as to what they buy based largely on price. More specifically, the change in the amount of a good purchased is often highly dependent on its change in price. That measure of responsiveness is defined as the price elasticity of demand. Mathematically, it is often expressed as: Ed= - percent change in quantity demanded / percent change in price, or -(dQ/Q)/(dP/P). The minus sign is often omitted because price elasticity of demand is presumed to be negative. If Ed = 0, it is perfectly inelastic, a change in price does not affect the quantity demanded. If 0 >Ed>-1, it is relatively inelastic, the quantity demanded does not increase at the same rate the price falls. If Ed = -1, there is unitary elasticity, both price and demand change equally. If -1>Ed, it is elastic, demand increases more than the fall in price. It is presumed that the changes in price are small. If the price elasticity of demand is not greater (more negative) than -1, a drop in price can actually reduce overall revenue received by the seller. Airline industry observers have generally assumed that the demand for airline travel is price elastic. Indeed, one of the primary benefits expected with airline deregulation was a fall in the fare level and increased passenger traffic were regulatory price and service restrictions removed. Economists also generally view the effect of price changes in inflation-adjusted terms, e.g. "real" prices. This paper examines the effect of changes in price on the demand for U.S. domestic air travel, in both nominal and inflation-adjusted terms. The paper shows, contrary to general economic belief, that the overall price elasticity of demand for air travel has been inelastic (e.g. more positive than -1.0) since the early 1970's in both real and nominal terms. Domestic industry price elasticity estimates are developed using multiple linear regression with demand measured in revenue passenger-miles as the dependent variable and several selected independent variables (price, the economy, consumer confidence, and several "dummy" variables). The paper is divided into four subsections: The Change in Air Travel Demand, The Regression Model Form, Model Variables, and Results and Conclusions.