Case Study 1 (10 marks)

Why a Big Swing in Jet Fuel Costs Brings Small Change to Airfares By Eric Morath Jan. 16, 2015 4:28 pm ET Cheaper oil is finally starting to push down prices for airline tickets, but the savings might not be as much as fliers expect. U.S. airline fares fell 5% in December from the prior month, the Labor Department said Friday. While the drop is steep, it comes after monthly price increases in October and November. Passengers were perplexed in those months why airfares were rising even when global oil prices were plunging. From a year earlier, jet fuel prices were down 23.5% in December, but airfares were down a narrower 4.7%. What gives? One reason is fuel costs account for just 26% of the price of an airline ticket, according to the trade group Airlines for America. Other parts, including taxes and labor costs, are holding steady or rising. Another factor is profits. Airlines rarely pass along all the fuel savings to customers. Instead, lower fuel prices have analysts expecting a strong year for airlines' bottom lines in 2015. At the same time, when fuel prices spike, airlines can't push all the additional cost onto customers. For example, in March 2010, fuel prices were up 75% from a year earlier but airfares were up 7.5%. Airlines, of course, don't fill up at the local gas station. Some enter into long-term contacts to guard against price fluctuations and those contracts could limit their ability to move fares quickly based on fuel-price changes. Jet fuel prices come from a separate Labor Department report, the producer price index, that tracks the prices businesses charge to end-users for their products. In the case of jet fuel, that end-user is an airline or another aircraft operator. Airline prices, because they are at least partially tied to oil, do weigh on important inflation measures. Airfares account for about 1% of the basket of products that make up the consumer price index excluding food and energy. If airfares were also removed from those so-called "core" prices, the measure would have increased 0.1% in December rather than held flat, said Ian Shepherdson, chief economist at Pantheon Macroeconomics. Core prices were depressed by a "plunge in airline fares, which have much further to fall," he said.

Questions on Case Study 1 1. Elaborate on the concept/law regarding demand discussed in the article. (2 marks) 2. State the reasons given (in at least 100 words) for such changes in the airfare to changes in the fuel prices. (4 marks) 3. Use supply and demand analysis to determine whether the change in the airfare accurately reflects the law of demand and supply. (4 marks)