Sample Economic Analysis (Hypothetical Scenario): "Oil at $100 per Barrel"
The airline industry has become a significant aspect of any economy as it provides cost and time-efficient transportation of goods and passenger travel. As such, any changes in the industry can affect the economy. Issues with airplanes and flights can delay important economic deliveries and a drastic increase in cost can make travel more expensive. One particular issue that the airline industry faces today is the elevated price of crude oil. Currently, a barrel of crude oil costs around $85 to $100, a significant increase over the last five years. This economic analysis will examine how the price of crude oil affects the airline industry.
Primary Economic Elements
In examining the effects of elevated crude oil prices, it is helpful to recognize the economic elements integral to the problem. Oil prices directly affect inflation rates and economic growth as they influence transportation, mining, manufacturing, and other sectors (Sarmah & Bal, 2021). Therefore, elevated oil prices can cause various changes for businesses, households, and the economy. The economic elements to examine are price, household income and wealth, and oil competitors.
The main problem in this analysis is the elevated crude oil prices. According to current price reports, WTI crude oil is around $87 per barrel, Brent crude oil is around $90 per barrel, and Tokyo crude oil is around $500 per kiloliter (Energy, 2022; Crude Oil Price, 2022). These place the average crude oil price at around $85 per barrel or per 160 liters. However, previous data from early 2022 show that crude oil prices went up to $105. Prices show a slow decline but current trends indicate future price increases. Additionally, taking into account the pandemic and other global crises, such as the Ukraine-Russia conflict , prices may continue to increase. Since oil is an essential economic product, the price element will detrimentally affect businesses, such as the airline industry.
Household Income and Wealth
Household income and wealth are economic elements that affect consumers and businesses. Increases in household income mean consumers have more to spend and businesses can expect higher sales. Alternatively, low household income limits consumer spending, leading to lower sales for businesses. With regards to elevated oil prices, negatively affects household income and wealth. According to Stevens (2022), high oil prices will result in less consumer spending due to high product prices and other economic effects. Households will experience lower wages, salaries, and other earnings while decreasing the capacity to save. This will have detrimental effects on the living conditions of every household, especially for poorer demographics.
Furthermore, elevated oil prices can affect consumer behaviors, tastes, preferences, and expectations. With lower household income, consumers will prefer to purchase cheaper products and attempt to save money when they can. However, since elevated oil prices also decrease household wealth, the capacity to save becomes challenging. Aside from low wages, expenses, such as rent and electricity bills, will increase since businesses will have to compensate for the economic effects of elevated oil prices. This will drastically change consumer behavior from their original buying behavior when oil prices were normal.
Lastly, oil competitors are essential economic elements in the discussion. Elevated oil prices mean that competitors can expect a rise in demand. Consumers will want to find better alternatives that will allow them to save money. Simply put, paying high prices for oil may seem inefficient when there are alternatives in the market, such as solar power, electric battery, and wind power. This situation will lead consumers to look for efficient alternatives, specifically clean energy (Clifford, 2022). For instance, consumers may prefer to use products or services that utilize alternative energy sources to save money. They may expect that oil prices will continue to rise and create decisions based on this fact. Therefore, companies that use alternative energy, such as electric car manufacturers, can benefit from elevated oil prices.
Impact on Airline Costs and Pricing
Elevated oil prices mean that airline companies must face increased costs in their operations. According to Scott Kirby, United Airlines’ CEO, the elevated oil prices including jet fuel can cost the company to spend $10 billion more than in 2019 (cited in Clifford, 2022). Biesterfeld, the CEO of C.G. Robinson, also stated that carrier flights from Los Angeles to the East Coast may increase their costs by $1,000 more than in 2021 (cite in Clifford, 2022). These cost increases are based on the current oil prices, which are below $100. If oil prices elevate to more than this value, the cost increases will be higher, leading to extremely expensive prices.
The issue of airline costs and pricing revolves around various production factors in the industry. These include indivisible fixed costs, specialization, purchasing, and research and development. Airline companies have fixed costs that they cannot scale down to compensate for elevated oil prices. Therefore, service costs can only increase. However, other factors, such as purchasing and research and development may provide ways for a company to decrease expenses. For instance, a company can ask suppliers lower prices for large orders to secure steady demand. Additionally, research and development can discover innovations that can lead to cost reduction.
Airline Competitor’s Reaction to Elevated Oil Prices
Similar to crude oil competitors, airline competitors can expect increased demand due to elevated oil prices. According to Folger (2021), elevated gas prices shift the market to use public transportation instead of private vehicles. Instead of paying more for gas, consumers are likely to shift to riding buses or trains to save money. This can extend to the airline industry since the increased cost per flight will make it less desirable. This is especially true for short-distance passenger flights. For instance, if a flight from Los Angeles to the East Coast is worth $1,000 more than the base price, consumers will prefer to use buses, trains, or other cheaper modes of transportation. Still, some consumers may continue to use air travel, especially if time is an essential factor.
Factors Driving Demand for Air Services
Consumer Income and Income Distribution
Examining the factors that drive demand for airline services is crucial in understanding how elevated oil prices will affect the industry. The first factor is the consumer or household income which the paper previously discussed. Lower income due to the effects of elevated oil prices means that consumers will want to use cheaper alternatives. They will look to the airline industry’s competitors, such as buses and trains. This will negatively affect the demand for airline services since they become an expensive and less economic choice. However, taking into account the distribution of income and population can be beneficial for the airline industry. They can target high-income and high-populated areas which may have better demands for their services.
Price of Alternatives
The price of alternatives is one of the most influential factors for airline demand during times of elevated oil prices. As mentioned earlier, high oil prices lead consumers to use alternative modes of transportation. Consumers would rather spend $200 from New York to Los Angeles than spend twice as much for a flight to the same destination. Furthermore, high oil prices have led manufacturers to create fuel-efficient cars to address the increased costs and consumers are buying these alternatives (Folger, 2021). This can have long-term effects on air service demand since consumers have a cheaper alternative that they can use regardless of oil prices. So even if oil prices decline, demand for airline services may be lower than normal, especially for short-distance flights.
Price of Complements
Oil is one of the complements in the airline industry as it is a necessary material for their operations. If oil prices are high, the overall cost of running an airline will increase. This will increase ticket prices and other charges since airlines will have more expenses. If other complements also increase, such as airline food prices and other materials, expenses will further increase. As such, the prices of complements are integral factors that will affect the demand since airline companies cannot consistently pass down the expenses to customers.
Effect of Technology on the Airline Industry
Technological advancements have been beneficial for the airline industry. Innovations in engineering, programming, and navigation have impacted airline companies’ operating costs, ticket prices, and overall expenses. Programs that allow effective and efficient manufacturing designs have significantly reduced production costs (Technology in the Airline Industry, n.d.). New improvements in this aspect can further reduce the cost which is desirable because of elevated oil prices. Furthermore, other technological innovations, such as the use of alternative energy to power airplanes, may make airline services cheaper and not rely on oil. For instance, engineers have created the MagniX Cessna Caravan electric plane which costs around $6 for a 160 km local flight (Tountas, 2021). This is a significant price reduction considering that the same flight is worth around $400 in a liquid fuel plane. However, since these innovations are still in development, they cannot affect the current demand and price of airline services.
The airline industry is likely to suffer because of elevated oil prices. The economic pressure from the pandemic, the Ukraine-Russia conflict, and other issues forces consumers to spend less and look for cheaper alternatives. Since forecasts show that oil prices are likely to increase, the situation will worsen. Airline companies will have to charge more since they will spend more on operations. Therefore, they must find ways to reduce costs, increase demand, and compete against alternatives.
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Folger, J. (2021). How Gas Prices Affect the Economy. Investopedia. Available at https://www.investopedia.com/financial-edge/0511/how-gas-prices-affect-the-economy.aspx . Accessed: October 11, 2022.
Energy. (2022). Bloomberg. Available at https://www.bloomberg.com/energy . Accessed: October 11, 2022.
Sarmah, A. & Bal, D. (2021). Does Crude Oil Price Affect the Inflation Rate and Economic Growth in India? A New Insight Based on Structural VAR Framework. Available at https://journals.sagepub.com/doi/pdf/10.1177/0019466221998838. Accessed: October 11, 2022.
Technology in the Airline Industry. (n.d.). Cs.odu.edu. Available at https://www.cs.odu.edu/~tkennedy/cs300/development/Public/M08-TechnologyintheAirlineIndustry/index.html. Accessed: October 12, 2022.
Tountas, A. (2021). Getting Renewable Energy in the Sky With Better Aircraft Designs. Advanced Science News. Available at https://www.advancedsciencenews.com/getting-renewable-energy-in-the-sky-with-better-aircraft-designs/. Accessed: October 12, 2022.