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Soaring Jet Fuel Prices and U.S. Airlines

EconEye Admin

Jet fuel prices rose from $2.50 per gallon before the Iran war broke out to $ 4.13 on May 1 leading airlines to raise ticket prices and reduce the number of routes. The shock was especially severe for Spirit Airlines, which exited the market on May 2.—wsj.com and airlines.org

Use the following notation to work the questions in the multiple choice quiz below:

Price — P

Average total cost — ATC

Average variable cost — AVC

Average fixed cost — AFC

Marginal cost — MC

Answer the following questions to check your understanding of the story.

How has the rise in the price of jet fuel changed the cost curves of an airline?

It has made _____ higher for every flight, but not changed _____.

Wrong! - MC, AVC and ATC do change with fuel prices. AFC remains unchanged.

Good Job! - Higher fuel prices increase variable cost and shift the MC, AVC and ATC curves upward, while AFC curve remains unchanged.

What is an airline’ profit-maximizing response to a rise in the price of jet fuel?

An airline’s profit-maximizing response to a rise in the price of jet fuel is _____ in the number of miles flown and a _____ in the price of a ticket.

Wrong! - A higher quantity and a lower price implies a downward shift in the MC curve. With constant demand, quantity and price move in opposite direction.

Well Done! - MC curve shifts upward to intersect the MR curve at a lower quantity and a higher price (fewer miles flown and higher ticket price).

Which routes have been shut down by the airlines after the rise in fuel cost?

Airlines shutdown routes where _____.

Wrong! - If P exceeds AVC, the route will operate. ATC is irrelevant for shut-down decisions. A route that generates zero economic profit covers both variable cost and fixed cost and should operate.

That's Right! - When AVC > P, total revenue from the route is not enough to cover the variable cost, let alone the fixed cost.

Which routes do airlines continue operating despite incurring economic losses?

Routes where ______.

Wrong! - P can’t be above ATC and below AVC at the same time. ATC = P is the break-even point, not an economic loss. This is the shutdown point. An airline would not operate any route at this price and below it.

Correct! - If ATC has risen above P, but AVC is still below it, some revenue is left after paying the variable cost which helps cover part of the fixed cost.

Which routes are still profitable and what happens to their profitability after the rise in fuel cost?

Routes where ______ but profits are _____ after the rise in jet fuel price.

Wrong! - With elastic demand, higher price will decrease total revenue, and higher fuel cost will increase total cost. Profit will not be higher.  An airline makes a zero profit on a break-even route, AVC < P is not sufficient for profit because ATC may still exceed P.

You Got It! - ATC < P implies a profitable route where total revenue exceeds total cost, but with elastic demand, a higher price reduces total revenue, while higher fuel cost increases total cost, reducing profit.

Why did Spirit airlines exit the market?

Spirit exited because it’s ______, and it expected its economic losses to be ______.

Wrong! - Temporary losses don’t trigger exit. AVC related to short-run shutdown decision, not long-run exit decision. MR = MC determines output, not exit.

Well Done! - Exit occurs when ATC rises above P and the firm expects the losses to be permanent.

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