The Principle of Market Equilibrium

Devin Bunten 828. 008. 840 As costs rise, airlines cut services and raise fares International Herald Tribune Micheline Maynard Friday, June 6th, 2008 www. iht. com/articles/2008/06/06/business/air. php The Principle of Market Equilibrium The equilibrium price is the price at which the quantity demanded of a good or service is equal to the quantity supplied. The Principle of Market Equilibrium states that perfectly competitive markets are always moving toward said equilibrium.

If the price is too high or low, there will be a surplus or shortage, respectively, which will drive the price towards the “market-clearing” equilibrium price. When there is a shift of the demand and/or supply curves, the market will adjust by finding a new equilibrium price. Such is the case in the airline industry, where a decrease in supply has led to a rise in the equilibrium price and a fall in the equilibrium quantity.

Costs in the airline industry, as in many industries at present, are rising, largely due to an increase in the costs of inputs. The cost of fuel this summer is “almost double” what it was last summer. This has led to a shift inward of the supply curve for the airline industry; that is, at any given price, airlines will now supply fewer flights. This has been made tangible by the announcements since March that the industry will be retiring more than two hundred aircraft.

However, a shift inward of the supply curve is also a shift upward, and airlines are following this stricture of economics as well: various airlines have begun charging between fifteen and twenty-five dollars to check bags, that is, the price has gone up for a service that was once offered at a lower cost to consumers. However, the movement of the supply curve is only half the story. For the purposes of this essay, the assumption is that the demand curve has not moved, however, there has certainly been movement along the demand curve. In addition to the aforementioned hanges, airlines are simply raising their rates. Southwest Airlines, which once would charge no more than $299 for any flight, now routinely charges $400 for some flights. This increase, while a hefty 33% over previous prices, is standard across the market. Correspondingly, the Air Transport Association, an industry lobbyist, has predicted a decrease in the number of people flying of two million from last summer to this. This decrease in quantity demanded, together with the increase in price, corresponds to a leftward movement along the demand curve, towards a new equilibrium.

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Faced with rising input prices, producers were unwilling or unable to meet the demand at the previous price level, creating a surplus of demand at that price. Producers have therefore responded by increasing prices (as well as, of course, cutting services). This is reflected by the decrease in quantity demand as the price rises. This increase in prices, combined with a decrease in quantity demanded, corresponds to the market finding a new equilibrium—one with far fewer flights, higher prices, and unhappy people on both the side of the producers and that of the consumers.

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