During the course of the Committee's hearing yesterday on the transportation tax, you asked a question concerning the impact of higher airline prices on travel demand. I agreed to provide you and the committee with documentation that shows that as airline prices increase, travel demand decreases and revenue does not increase. This phenomenon underlies the airline industry's inability to pass on to our customers the higher cost of the jet fuel tax scheduled to be imposed on our industry on October 1, 1995. Furthermore, it demonstrates why airlines were unable to raise prices to cover increasing costs over the past five year period during which we incurred net losses in excess of $13 billion. The attached material constitutes Appendix G of the May, 1995 Report of the Secretary of Transportation to the United States Congress, prepared pursuant to Section 522 of the Federal Aviation Administration Authorization Act of 1994, P.L. 103-305. This material comprehensively summarizes ten airline price elasticity studies. The price elasticity varied from -0.6 to 4.5 with an overall average of -1.4. The interpretation of these figures means that if airline prices increase by 1 percent, demand for airline tickets will decrease by between 0.6 and 4.5 percent with the overall average decline being about 1.4 percent. Since these negative elasticities range depending upon the type of ticket or traveler, for simplicity carriers use the -1 percent which I cited in my testimony. This fundamental relationship between price and demand underlies the relentless drive of the airlines to lower prices in order to increase volume and revenues. It is this relationship which gives the industry great concern about the steady pressure on our cost structure being driven by higher taxes, user fees and more costly regulations. A $500 million per year fuel tax will force our carriers to absorb the cost through a variety of different ways. These include: reduced airline service; lay-offs; reductions in wages and benefits; and a scaling back of equipment purchases, which will in turn have an adverse effect on manufacturers and suppliers. The proposed fuel tax would increase our costs by more than $500 million per year and seriously harm the airlines' efforts to return to sustained financial health. If there is any additional information I can provide, please let me know. Sincerely, Sincere Carol B. Hallett President and Chief Executive Officer Air Transport Association of America 1301 Pennsylvania Ave., NW - Suite 1100 Washington, DC 20004-1707 (202) 626-4168 FAX (202) 626-4166 APPENDIX G PRICE ELASTICITY OF DEMAND - LITERATURE REVIEW AND APPLICATION G. PRICE ELASTICITY OF DEMAND LITERATURE REVIEW AND APPLICATION More than 25 price elasticity studies were reviewed to determine which ones were most applicable for the analysis of child restraint systems. Summaries of the 10 most applicable studies follow. The summaries include the strengths and weaknesses of each study in the context of the CRS environment and the price elasticity estimates most relevant to the CRS study. These studies were selected because the work was respected for its applicability to air travel. This appendix divides the studies into two groups-those based on data collected after airline deregulation and those based on data collected during the regulated time period prior to 1978. Complete bibliographies of these studies are listed in Appendix H, References. Finally, a description of the analytical method used to implement the price elasticities is given. The reasons for choosing this method and its properties are provided. STUDIES BASED ON DATA COLLECTED AFTER AIRLINE DEREGULATION The five studies in this section develop price elasticity of demand values for various types of market segments. Each study is based on data collected after the 1978 airline deregulation. Apogee Research Incorporated, 1994 (see citation number 4 in the references). Apogee developed three models for business travel and three models for nonbusiness travel to project future air travel demand. The business travel models incorporated economic measures, such as corporate profits, gross domestic product (GDP), total business sales, and employment. The nonbusiness travel models included measures of disposable income, gross domestic product, and personal consumption expenditures. After developing these models, Apogee found the nonbusiness travelers to be more price-sensitive than the business travelers. The price elasticity estimates varied more for the nonbusiness travelers than they did for the business travelers. Also, the price elasticity for nonbusiness travelers was generally in the elastic range, while business travelers were price-inelastic. This study presented the following price elasticities: In general, nonbusiness travelers exhibited elastic demand in two out of three models, with an average value of -1.1. Business travelers exhibited inelastic demand in all three models, with an average value of -0.59. These elasticity estimates were for nationwide travel and are not attributable to any more detailed passenger groupings other than business and nonbusiness passengers. Directions: The Final Report of the Royal Commission on National Passenger Transportation, 1992 (see citation number 9 in the references). This study evaluated the effect of price changes on intercity travel within Canada. Nine econometric models of intercity passenger travel demand were used to calculate price elasticities for four Canadian travel markets. The identical travel market data base was used as input data for each model. This study directly compared the results of nine econometric models for both shortand long-haul markets. Because a consistent data base was used, the results of the nine models provided a homogeneous range of price elasticities for each market. However, several of the models produced price elasticity estimates that were outside the range of values found in the U.S. studies-the air traveler price elasticity estimates found in U.S. studies generally ranged from -0.8 to -2.7. The results of the Canadian study were adjusted to conform to the range of U.S. values by discarding any price elasticity estimates outside of that range. The result was that no clear relationship exists between price elasticity and trip length. Therefore, the Canadian study was not used to determine air traveler price elasticity differences by distance. However, this study suggested that low-income travelers have higher price elasticities than high-income travelers and nonbusiness travelers have higher price elasticities than business travelers, as follows: The price elasticity values produced by this model are high, and the Canadian study recognizes that they are high. But the trend was consistent with the opinions of expert panelists, who stated that low-income air passengers probably exhibited more price-elastic behavior than high-income travelers and nonbusiness travelers probably exhibited more price-elastic behavior than business travelers. • Oum, Gillen, and Noble, 1986 (see citation number 30 in the references). This study derived a model for business and nonbusiness travel demand. Route-specific aggregate cross-sectional data from 200 intra-U.S. routes were used, but the data were not available separately for business and nonbusiness travel. The researchers were able to aggregate the flights into three fare classes: first class, standard economy, and discount. The following summarizes the results of this study: Oum, Gillen, and Noble state that, "a majority of first class users are business travelers." If it is assumed that first class passengers represent the same price elasticity behavior as business travelers, and discount economy passengers are representative of nonbusiness travelers, this study then suggests that price elasticity values for business travelers are less elastic than those for nonbusiness travelers— approximately 50 percent less elastic. In addition, this study may support price elasticity values ranging from -1.5 to -2.0 for nonbusiness travelers. Oum, Zhang, and Zhang, 1993 (see citation number 32 in the references). This research analyzed the competitive interaction among airlines serving the same route markets. The authors were concerned that very few airlines dominated a large number of routes, thus creating oligopolies especially on routes connected to major hubs. In particular, the authors investigated the cross-sectional price elasticity difference for passengers traveling between 20 city-pairs, based on the Chicago O'Hare hub, for both American Airlines and United Airlines. For these 20 city-pairs, there was no correlation between an increase in trip distance and a change in price elasticity. The price elasticity values ranged from -1.24 to -2.34 with an average value of -1.58. Both Las Vegas and Reno exhibited price elasticities of greater magnitude than -2.0. These two destinations primarily attract nonbusiness passengers. For this reason, the results of this study suggest that nonbusiness price elasticities have magnitudes greater than -2.0. Oum, Waters, and Yong, 1992 (see citation number 31 in the references). This study surveyed transport demand price elasticities from previous research. In addition to air travel demand, it investigated the demand elasticities for automobile, urban transit, rail, and freight transportation. The cross-sectional air travel price elasticities were drawn from 13 separate studies. Only two studies disaggregated the air passengers by business or leisure travel purposes. The results of those two studies are: Other studies based on cross-sectional data did not differentiate among passenger types. The values of the price elasticities from those studies ranged from -0.76 to 4.51. Two conclusions were drawn from reviewing this study. First, the business travel price elasticity is lower than the leisure travel estimate—in this case about 25 percent lower. Second, the literature provides a wide range of price elasticity values, but this study did not specify which type of passenger had the greatest elasticity. STUDIES BASED ON DATA COLLECTED PRIOR TO AIRLINE DEREGULATION The following studies used data collected prior to the airline deregulation of 1978. The results and conclusions of these studies are still applicable, but they should be interpreted in the context of the deregulated environment. Abrahams, 1983 (see citation number 1 in the references). This study analyzed the demand for air carrier services resulting from fare, traffic, and service quality. The premise of this study was that air fare and the value of time spent using air carrier services were the two major costs faced by air travelers. The study used data of domestic U.S. city-pairs collected during the period from 1973 through 1977. The major findings of this study are: Florida vacation city-pair price elasticity: -1.98 -1.81 -1.68 -1.22 Vacation travelers, assumed to be nonbusiness passengers, dominated the first three route segments. Each of these markets was quite price-elastic with values ranging from approximately -1.7 to -2.0 during the period of airline regulation. Nonbusiness travelers in today's market may exhibit more price-elastic behavior because of the deregulated, price-sensitive environment. De Vany, 1983 (see citation number 8 in the references). This study estimated the value of time in air travel. It is based on the increased awareness of such qualitative and quantitative aspects as congestion and delays. De Vany analyzed the top 600 U.S. domestic travel markets in 1968. He derived a "full price elasticity" that was the sum of price and time elasticities. This sum did not vary significantly with distanceits value was approximately -1.5 for trip distances ranging between 28 and 2500 miles. Similar to the Ippolito study, the price elasticity component of the full price elasticity did increase with distance as shown: De Vany stated, “ These estimates are calculated from the regressions of fare and time on miles and are subject to error." These results are questionable because, in models with two correlated variables, one often influences the other. Therefore, it may be more appropriate to consider the full price elasticity instead of the price elasticity alone. This study did not differentiate between business and nonbusiness travel. The dominant number of business travelers on short trips may have increased (made less negative) that price elasticity; the greater number of nonbusiness travelers on longer trips may have reduced (made more negative) that price elasticity value. In general, this article suggested that the air travel demand is elastic. • Ippolito, 1981 (see citation number 18 in the references). This study estimated the impact of quality-of-service variables-flight frequency, availability of seating, flight distance on the level of air carrier demand. The study drew its data from a sample of 105 flight segments in 1976. Ippolito confined his study to flight segments in which one air carrier held a monopoly. He found that price elasticity increased with flight distance. His results are summarized below: These results are difficult to apply to the CRS study because they are based on prederegulation data and they involve monopoly routes. Price competition is totally removed from Ippolito's analysis. The results of this study were not applied to the CRS analysis because the proportion of business to nonbusiness travelers was not specified. It is possible that business travelers dominated the shorter distance trips and caused the inelastic demand, but the study does not address this issue. Morrison and Winston, 1985 (see citation number 24 in the references). This study estimated intercity vacation and business traveler transportation demand. It drew upon data from the 1977 Census of Transportation National Travel Survey, which contains a sample of trips with round-trip distances greater than 200 miles. The model developed by Morrison and Winston first assumed selection of a destination city and then determined the mode of transportation that would be used to reach that destination. The four transportation modes considered were automobile, bus, rail, and airplane. Morrison and Winston presented elasticity estimates for three components of air travel demand-cost, travel time, and time between departures. Their price elasticities for air travel were: The above price elasticity values are considerably lower than those listed in the previously cited studies-studies of data of later origin show more elastic demand. Morrison and Winston recognized that these values were low and that the demand for air travel is probably elastic. In fact, the authors state in their footnote number 25 that other studies (e.g., De Vany) find the demand for air travel to be priceelastic. Morrison and Winston note that the estimates provided by De Vany include all three components contained in their Table 3 (cost, travel time, and time between departures). It is likely that price elasticities obtained from the mode choice elasticities and destination choice elasticities reported would be consistent with the findings of some other studies. |