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  • Print publication year: 2009
  • Online publication date: June 2014

3 - Using logs and estimating elasticities

Summary

Economic issues include:

Inverse demand curves

Elasticities

Income and substitution effects

Normal, inferior and Giffen goods

Econometric issues include:

Model specification: using logs to estimate elasticities

Running regressions using Excel

Hypothesis testing: one-tailed t tests

Data issues include:

Data constraints

Proxy variables

The issue

If you were the manager of the London Underground or American Airlines would you raise ticket prices, or drop them? Which strategy would maximise your firm's profits? The ‘law of demand’ states that if prices are lowered then there will be rises in demand. But this doesn't necessarily mean that a firm should just lower prices if it wants to boost revenue. Other effects operate too and the net result will depend on how sensitive consumers are to changes in price. If for some reason consumers are determined to have only a certain amount of a particular good or service then lowering prices may make little difference to the amount demanded and so a firm's revenues might fall because they are selling similar quantities but at lower prices. For example, if you manage an airline and your consumers don't care much about price; if they are not motivated to travel more even when flights are cheaper, then total revenues would fall, perhaps so much that costs could not be covered (and you would probably be looking for a new career).

Further reading
Textbooks
Grant, S. and Bamford, C. (2006) Transport Economics (4th edition), Oxford: Heinemann Educational Publishers.
Varian, H. (2006) Intermediate Microeconomics (7th edition), London: W. W. Norton & Co. Chapters 5–6 and 15.
Journal articles
Brons, M., Pels, E., Nijkamp, P. and Rietveld, P. (2002) ‘Price elasticities of demand for passenger air travel: a meta-analysis’, Journal of Air Transport Management, vol. 8, no. 3, 165–75.
Ito, H. and Lee, D. (2005) ‘Assessing the impact of the September 11 terrorist attacks on the U.S.airline demand’, Journal of Economics and Business, vol. 57, issue 1, 75–95.
Verleger, P. K. (1972) ‘Models of the demand for air transportation’, Bell Journal of Economics and Management Science, vol. 3, no. 2, 437–457.
Policy reports
Gillen, D. W., Morrison, W. G. and Stewart, C. (2003) Air Travel Demand Elasticities: Concepts, Issues and Measurement, Department of Finance, Canada. See www.fin.gc.ca/consultresp/Airtravel/airtravStdy_1e.html