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Consider the market for airlines and assume that it is a perfectly competitive market
Consider the market for airlines and assume that it is a perfectly competitive market. Assume the U.S. domestic market is currently at equilibrium with a total of 642 million ticketed passengers per year at a price of $$375 per ticket. Suppose a study is released that documents large negative health effects of increased exposure to radiation from flying. In addition, suppose there is a sudden increase in the price of jet fuel. If demand is elastic, is the total revenue higher or lower?
Expert Solution
In this case, two things are happening.
- Demand is shifting left because of the negative effect of radiation from flying
- Supply is also shifting left because of higher jet fuel costs.
Thus we know for a fact the equilibrium quantity has fallen but we don't know which direction price has moved since the demand shift is pushing it down and the supply shift is pushing price up.
Let assume
- If the price moved down, then obviously total revenue would fall since both price and quantity fell.
- Now if the price rose, since demand is elastic, an increase in price would result in lower total revenue anyway.
Thus, total revenue must be lower.
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