Airline Fares Are Declining – Aren’t They?

A recent AP article published by ABC piqued our curiosity. It is entitled “Why Airfare Keeps Rising Despite Lower Oil Prices.” Evidently, the authors felt an explanation was in order – maybe people have complained that air fares keep going up in spite of declining fuel prices? We can’t be sure what motivated them to write the article, but here are a few excerpts:

U.S. airlines are saving tens of millions of dollars every week because of lower prices for jet fuel, their largest expense. So why don’t they share some of the savings with passengers?

Simply put: Airlines have no compelling reason to offer any breaks. Planes are full. Investors want a payout. And new planes are on order.

In fact, fares are going higher. And those bag fees that airlines instituted in 2008 when fuel prices spiked aren’t going away either. In the 12 months ended in September, U.S. airlines saved $1.6 billion on jet fuel. That helped them post a 5.7 percent profit margin in the first three quarters of this year, robust for the industry but lagging behind the 10 percent average for the Standard & Poor’s 500.

In the past six years, airlines have done a great job of adjusting the number of flights to fall just short of demand. As a result, those who want to fly will pay a premium to do so.Airlines are selling a record 85.1 percent of their domestic seats. Thanks to several mega-mergers, four big airlines control the vast majority of flights, leaving very little room for another airline to undercut fares. With that in mind, here’s a closer look at what’s going on with airfare and the price of jet fuel:

— The average domestic airline ticket during the 12-month period ending in September rose 3.5 percent to $372.21, according to an Associated Press analysis of data from the Airlines Reporting Corp., which processes ticket transactions for airlines and travel agencies. That figure doesn’t include another $56 in taxes and fees that passengers pay.

— In the 12-month period ending in September, U.S. airlines burned through nearly 16.2 billion gallons of fuel. They paid an average of $2.97 a gallon — down from $3.07 the prior year, according to the Bureau of Transportation Statistics. That 10-cent drop saved the industry $1.6 billion. Fuel prices have since fallen further. United Airlines estimates it will pay $2.76 to $2.81 a gallon during the last three months of the year.

– Put another way: U.S. airlines burn through 311 million gallons of fuel in a week. Lower fuel prices are saving them $31 million a week.”

(emphasis added)

Actually, we are not really interested here in the reasons why air fares keep rising, or how airlines have managed to keep them high and have been able to avoid passing their fuel savings on to consumers. Undoubtedly that would make for an interesting topic as well.

 (Photo credit: fmh)

Are Consumer Choices on the Retreat?

As an aside to this, a brief comment on a related topic: we have a nagging suspicion – based largely on anecdotal evidence and on what economic theory would predict – that we are beginning to see some of the effects of decades of off-and-on capital consumption due to government intervention in the market economy. While improved communication allow us to see more of the choices we have in terms of consumer products, there are subtle signs that many of these choices are not real.

A German TV crew recently investigated 50 different plumbers in a mid-sized town and found out that they were the franchisees of just two firms. So there were not really 50 different independent plumbers with 50 offering different levels of services and different products – in reality, there were just two. These franchisees are small businesses in a way, but only in name. From the consumer’s point of view they are indistinguishable.

We recently compared notes with a friend to see whether we could observe similar phenomena elsewhere as well. After exchanging some anecdotes about items that one should theoretically be able to buy, but can actually not get, we concluded that a great many of the consumer goods that exist in catalogs apparently existonly there.

Could it be that much less is produced than we thought? Readers will remember a chart we often show that compares capital to consumer goods production in the US. What is interesting is that not only the ratio between the two has risen to new highs, but that the consumer goods production index has actually declined quite sharply in absolute terms as well.

 Airline Fares – Discrepancies in Government and Industry Data

Anyway, to come back to airfares, we want to focus specifically on one of the sentences highlighted above, namely: “The average domestic airline ticket during the 12-month period ending in September rose 3.5 percent to $372.21, according to an Associated Press analysis of data from the Airlines Reporting Corp., which processes ticket transactions for airlines and travel agencies. That figure doesn’t include another $56 in taxes and fees that passengers pay.”

If airline fares rose 3.5% over the past twelve months (excluding tax surcharges), we should expect this to show up in the consumer price index. In fact, consumer price indexes are calculated separately for the various components making up the basket. So what does the airline fares price index published by the Bureau of Labor Statistics show? See for yourself:

Airline fares according to the government’s CPI statistics. Something seems not right with this…the BLS says they have decline by more than 3% year-on-year, not risen by 3.5% – via St. Louis Fed 

We can only surmise that the quality of air travel must have increased so tremendously over the past year that a rise in airline fares in nominal terms became a decline in “hedonically indexed” terms.

Conclusion:

It is actually not really possible to calculate a “general price level”, since there is no constant against which prices could be compared. The reason is that the supply of and demand for both goods and services and money continually changes. However, it is certainly possible for people to notice whether their incomes buy more or fewer goods and services over time – the fact that the purchasing power of fiat money declines over time is not exactly a big secret.

People often complain that the calculation of CPI has become deeply flawed (leaving the deliberations above aside for the moment). Partly this is due to the bias of observers, as everyone buys a slightly different basket of goods, and partly it is due to the fact that the methodologies employed have over time been redesigned so as to show as little “price inflation” as possible. Although this was never presented as the reasoning behind the methodological changes, one major effect is that it cuts down on government spending on social security and other expenses tied to cost of living adjustments.

Among the flaws are the very subjective interpretations of how the changing quality of goods should be reflected (which is of course assumed to always improve) and the regular change of the weightings of goods in the basket based on the idea that people will buy less of what becomes more expensive. This of course also means that the index reflects something slightly different every time.

We’re not sure what has created the discrepancy between the change in airline fares as reported by the ARC (which actually provides data on millions of tickets every year) and that reported by the BLS. It is certainly interesting though – there is after all a vast difference between prices rising by 3.5% or falling by slightly over 3% in the space of one year.