Case study 3.3: The Texas state bird
Southwest Airlines is a major carrier based in Texas, and has made a strategy of cutting fares drastically on certain routes with large effects on air traffic in those markets. For example on the Burbank-Oakland route the entry of Southwest into the market caused average fares to fall by 48 per cent and increased market revenue from $21,327,008 to $47,064,782 annually. On the Kansas City-St Louis route, however, the average fare cut in the market when South west entered was 70 per cent and market revenue fell from an annual $66,201,553 to $33,101,514.
Questions
1 Calculate the PEDs for the Burbank-Oakland and Kansas City-St Louis routes.
2 Explain why the above market elasticities might not apply specifically to Southwest.
3 If Southwest does experience a highly elastic demand on the Burbank-Oakland route, what is the profit implication of this?
4 Explain why the fare reduction on the Kansas City-St Louis route may still be a profitable strategy for Southwest.