Question

Let's think about the market for air travel. From August 2014 to January 2015, the price of jet fuel increased roughly 47\%. Using the four-step analysis, how do you think this fuel price increase affected the equilibrium price and quantity of air travel?

Short answer

The 47% increase in jet fuel prices leads to an increase in the cost of production for air travel, causing a decrease in the quantity supplied at each price level, resulting in a leftward shift of the supply curve. Assuming other factors affecting the demand for air travel remain constant, the demand curve stays unchanged. The new equilibrium point occurs at a higher price and a lower quantity, indicating that the increase in jet fuel prices causes an increase in the equilibrium price of air travel (higher prices for consumers) and a decrease in the equilibrium quantity of air travel (fewer air travel services available).

Step-by-step solution

Analyze the Demand for Air Travel

First, we need to analyze the demand for air travel. The demand for air travel is determined by various factors such as the income of consumers, preferences, prices of related goods, etc. In this problem, we will focus on the price of air travel. Since we're assuming that other factors that affect the demand for air travel remain constant, the law of demand states that there is an inverse relationship between the price of air travel and the quantity demanded, i.e., as the price of air travel increases, the quantity demanded for air travel decreases and vice versa.

Analyze the Supply of Air Travel

The supply of air travel is determined by the cost of production, which includes the price of inputs like jet fuel. Since the price of jet fuel increased by 47%, this leads to an increase in the cost of air travel production. According to the law of supply, there is a direct relationship between the price of a product and its quantity supplied, i.e., as the price increases, the quantity supplied also increases and vice versa. However, in this case, the cost of production is also increasing due to the increase in jet fuel prices. Therefore, it is expected that this increase in production costs may lead to a reduction in the quantity supplied of air travel as airlines may not be able to supply the same quantity of air travel at the previous price levels.

Determine the Initial Equilibrium Price and Quantity

At the initial equilibrium, the quantity demanded for air travel equals the quantity supplied. This equilibrium point can be determined using a demand and supply graph, where the quantity demanded and supplied are represented on the x-axis and the price is represented on the y-axis. The intersection of the demand and supply curves represents the equilibrium price and quantity.

Analyze the Effects of the Increase in Jet Fuel Prices

Given the 47% increase in jet fuel prices: 1. The cost of production for air travel increases, leading to a decrease in the quantity supplied at each price level. This results in the leftward shift of the supply curve. 2. The demand for air travel remains constant since we're assuming that other factors affecting the demand do not change. With the leftward shift of the supply curve and the demand curve remaining constant, the new equilibrium point occurs at a higher price and a lower quantity. This means that the increase in jet fuel prices leads to an increase in the equilibrium price of air travel (consumers have to pay higher prices) and a decrease in the equilibrium quantity of air travel (fewer air travel services are available).