Question

Suppose Glaswegians have a given income and like weekend trips to the Highlands, which are a three-hour drive away. (a) If the price of petrol doubles, what is the effect on the demand for trips to the Highlands? Discuss both income and substitution effects. (b) What happens to the demand for Highland hotel rooms?

Short answer

The demand for trips to the Highlands and for hotel rooms decreases due to higher petrol costs causing substitution and income effects.

Step-by-step solution

Define the Scenario

Initially, Glaswegians have a certain income and enjoy taking weekend trips to the Highlands, spending money on petrol for a three-hour drive. The cost of these trips depends primarily on the price of petrol and other associated expenses such as accommodations.

Analyze the Impact of Petrol Price Doubling

When the petrol price doubles, the cost of traveling to the Highlands increases significantly. This creates an impact on demand for trips due to two main effects: the substitution effect and the income effect.

Consider the Substitution Effect

With an increased petrol price, trips to the Highlands become more expensive relative to other forms of leisure such as local activities or staying at home. People might opt for closer or less costly weekend plans, reducing the demand for trips to the Highlands.

Consider the Income Effect

The more expensive petrol functions like a reduction in income because people now allocate more of their budget to travel expenses if they decide to go to the Highlands, leaving less money for other goods and services. This can lead to a decrease in the frequency of such trips, as some Glaswegians might find them less affordable.

Assess Demand for Highland Hotel Rooms

With a reduced number of trips to the Highlands due to the substitution and income effects, the demand for Highland hotel rooms is likely to decrease. Fewer travelers mean hotels will have fewer guests, directly impacting their occupancy rates.

Summarize Outcomes for Both Parts

Overall, the doubling of petrol prices leads to a decreased demand for trips to the Highlands due to both substitution away from the now more costly trips and reduced effective income. Consequently, this decreases the demand for accommodation in Highland hotels.

Key concepts

Income Effect

The income effect refers to how changes in the price of a good can feel like a change in a consumer's income. When petrol prices double, it's as if Glaswegians have less money to spend. This is because they now have to allocate more of their budget towards petrol if they choose to travel. Spending more on petrol means that they have less money available for other expenses, such as dining out or entertainment.

As a result, despite no change in their actual income, Glaswegians feel financially constrained. They might cut back on the frequency of trips to the Highlands or opt for cheaper alternatives, simply because the cost of the journey has increased so much relative to other goods and services. The perceived reduction in income makes them reassess how they spend their money on leisure activities.

Substitution Effect

The substitution effect occurs when consumers opt for a different good or service in response to a price increase. With the doubling of petrol prices, the cost of a trip to the Highlands rises significantly. This makes other forms of leisure, like enjoying time at local attractions or staying home, comparatively cheaper.

Glaswegians might decide to replace these costly trips with alternatives that fit their budgets better. Instead of traveling to the Highlands, they might choose activities closer to home that require less petrol. This change in behavior as people shift their spending from expensive to cheaper options highlights the substitution effect.

Consumer Behavior

Understanding consumer behavior involves looking at how individuals make choices about spending their money. When petrol prices increase, Glaswegians must reconsider their travel plans to the Highlands. They might weigh factors such as the necessity of the trip, alternative destinations, and the availability of discounts or cheaper accommodations.

Moreover, habitual patterns may also be disrupted. Frequent travelers may find themselves cutting back due to increased costs, while occasional travelers may decide against trips altogether. Consumer behavior is influenced by pricing changes, available income, and personal preferences, and such a significant rise in petrol prices can lead to noticeable shifts in how people decide to spend their weekends.

Travel Economics

Travel economics examines how people make decisions regarding travel in relation to economic factors like costs and personal finances. With a steep rise in petrol prices, the economics of taking a trip to the Highlands changes drastically for Glaswegians.

The increased travel costs can deter trips unless people find alternative solutions, like carpooling or finding cheaper accommodations. The demand for travel-related services, such as hotel rooms in the Highlands, might also decrease as fewer people decide to make the journey. Overall, travel economics tells us that as costs rise, people are likely to reevaluate how they travel, which can significantly alter the dynamics of local travel markets.