Economics as Applied to Tourism

1. Economics as Applied to Tourism Chapter 2

2. Modern Economics • Major Economic Theories Adam Smith, 1776 • Concepts of supply and demand, productivity growth over time, division of labor and specialization for productivity. • Responsible for theory of distribution of wealth. T.B. Say, 1803 • Say’s Law: the economy as a whole generates exactly the right amount of income to allow people to pay for the sale of all the goods that have been produced. • Also known as “Theory of circular flow”.

3. Modern Economics (cont.) • Major Economic Theories John M. Keynes, 1936 • New theory of aggregate demand inspired by the Great Depression. • Suggested increasing government spending in the economy would be necessary to support struggling economies. Milton Friedman, 1960s • Governments could set stable rates of growth in the money supply, allowing increases in GNP • Stagflation created a new direction in economic thought related to the rational expectations of the population as a whole regarding future economic behavior. • High inflation leads to high unemployment

4. Modern Economics (cont.) • Major Economic Theories Supply-side Economics (Reaganomics), 1980s • Cut taxes, lower personal taxes, saving and investment incentives, reduce capital gain taxes leads to economic recovery • National debt increases dramatically. Reagan’s supply-side economic policy • Regulatory reform in transportation, communication and financial services.

5. Economics defined • Economics defined • Social science that seeks to understand the choices people make in using their scarce resources to meet their needs and wants. • Based not in money or wealth, but in what people want • The study of choices are made in a social context. • Scarcity itself is a human phenomenon, since things do not become scarce until they become the object of human wants. • For our example, why does an individual choose to travel to one destination instead of another or to remain at home versus travel?

6. Economic choices • Economic choices • What goods and services should be produced? • How they should be produced? • Who should do which jobs? • For whom the results of economic activity should be made available? • These choices are made because of scarcity. • What goods and services should be produced? • The number of goods and services to be produced is immense. • Not enough goods and services can be produced to meet everyone’s wants. • A choice needs to be made as to how much of each service to produce.

7. Economic choices • How should these services be produced? • Factors of production are the basic inputs of used in producing all goods and services. • Labor, the contribution to production made by people working with their minds and bodies. • Capital, all productive inputs created by people. • Natural resources, anything that can be used as a productive input in its natural state. • Who should do which jobs? • Productive resources that are used to satisfy one want cannot be used to satisfy another at the same time. • For example, teachers cannot spend the same amount of time teaching as well as working for an airline

8. Economic choices • Whom should the results of economic activity be made available? • Opportunity cost is its cost of a good or service in terms of the foregone opportunity to pursue the best possible alternative activity with the same time or resource. • Productive resources that are used to satisfy one want can’t be used to satisfy another at the same time. • In economic terms, everything has an opportunity cost. • Care must be taken when measuring the cost as money: not all sacrificed opportunities take the form of money.

9. Economic choices • All spending that generates economic activity is believed to be salutary… • Business is stimulated, more work is available, goods are created and economic activity is generated. • Optimism stimulates economy and travel, opposite is also true.

10. The Law of Demand • The law of demand states that an inverse relationship exists between the price of a good or service and the quantity of the good or service that buyer demand, other things being equal.

11. Shifts in Demand • A change in demand due to a variable other than the price of the good or service itself will cause a shift in the demand curve • Rightward shift - Increase in the demand of one is caused by an increase in the price of another • Leftward shift - Decrease in the demand of one is caused by a increase of the price of another • Other factors: competition, other related business activities (airline price increase, for example), consumer’s disposable income, popularity of the destination or service and the public’s confidence about the future economy.

12. The Law of Supply • The Law of Supply states that a direct relationship exist between the price of a good or service and the quantity of good or service that producers supply, other things being equal. • Price of a good or service increases while other prices stay the same, producers are apt to produce a greater quantity of that good or service.

13. Equilibrium Point • Equilibrium Point • The price at which the quantity demanded equals the quantity supplied • The equilibrium of supply and demand is stationary in the sense that once the equilibrium price is reached, it tends to remain the same as long as either supply nor demand shifts. • When the price is below equilibrium, the quantity demanded exceeds the quantity supplied, buyers offer higher prices and vice versa.

14. Supply and Demand of Tourism Products • Supply and Demand of Tourism Products • Hotel • The supply and demand equation for hotels is kept off balance because of the long time required to build and bring a new hotel on line by the economic cycle. • Restaurants • Over supply due to easy entry, a reason why restaurant businesses show so many failures. • Airlines • Fierce competition with price wars—a complicated picture

15. Supply and Demand of Tourism Products • Supply and Demand of Tourism Products • Cruise lines • Doing well due to marketing by pairing flight with cruise packages • Rental cars • Supply can be more easily adjusted, as fleets can be moved quickly and can remain in service up to 20,000 miles for resale market. • Travel agencies • Over supply due to easy entry.

16. Factors Influencing Supply and Demand • Factors influencing supply and demand • Advertising, marketing skills and human motivation exert a tremendous influence on what people “supply” and “demand” • On one hand, there is a relationship—a change in one results in a change in the other • On the other hand, the relationship is heavily influenced by other factors, mainly, marketing efforts and skills and human motivation • Marketing efforts and skills: matching the products and services to the needs and wants of the consumers; the same hamburger sold with different prices and demand. • Travel destinations come and go depending on how they are perceived by the market

17. Veblen Effect Thorstein Veblen, 1929 • Conspicuous consumption: Practice of purchasing goods or services because of the status they bring. • The Veblen effect sets up new demand curves based on exclusivity and prestige. The higher the cost of an experience or product, the more desirable it may become. • Travel is a “preferred superior service” in that more is undertaken as incomes increase. • Economists like to classify goods and services into those that are preferred and those that are non-preferred. • Veblen Curve

18. Elasticity of Demand for Tourism • Elasticity of Demand for Tourism • Elasticity (sensitive to price changes) and inelasticity vary considerably, depending on the affluence of the traveler and reasons for the trip. • Elasticity is also about the degree to which the consumers are willing to pay for certain product or the willingness to pay • From an economic standpoint, price elasticities are important for the suppliers of tourism products, since they can have an impact on their total revenues. • TRs (total revenues: are equal to the price (P) of the good or service times the total quantity sold (Q). • Service is elastic if TR increases when there is a decrease in P • So the concept of the price elasticity is very important to the suppliers of the tourism products and services. • If the price elasticity is known, a supplier can increase the TRs by making adjustment to the price of the product.

19. Elasticity of Demand for Tourism • Impacted by numerous factors that are difficult to model. • Availability of equivalent substitute products • Relative importance of the product in a spending budget • Amount of time available to adjust to the price change • The status of the product as a necessity or luxury

20. Types of Elasticities Hendrick Houthakker and Lester Taylor, 1970 • Price elasticity in long-run • Consumers have a longer time to adjust to price changes • Price elasticity in short-run • Consumers have a shorter time to adjust to price changes • Income Elasticity of Demand • The Income Elasticity of Demand is the percentage change in the quantity demanded divided by the percentage change on income. • Products can be income elastic (greater than 1). Quantity demanded increase as income increases, but the quantity demanded increases faster than income. • Income inelastic (between zero and 1). Demand is unaffected when the price changes. • Negative income elasticity (less than zero). Increases in income will lead to a decrease in demand.

21. Utility of Tourism Consumption • Utility of tourism consumption • The demand for tourism is influenced by the economic concept of utility: the benefit or satisfaction that a person gets from the consumption of a good or service • The concept of Utility is an abstract concept such as the concept of travel experience • Attempts have been made to quantify the concept of utility. Adrian Bull presented an example of characteristics that could be included: • Luxurious Accommodations • Gastronomic range and quality of real experiences • Quality and amount of personal service throughout trips • Reliability of transportation • Prestige name suppliers of tourism services • If these characteristics could be quantified, the tourist’s utility would be maximized.

22. Utility of Tourism Consumption • Total Utility • The total satisfaction that a person gets from the consumption of goods and services. • It is limited by the amount of disposable income available, the price of the desired goods and services, and in many cases, the time available to consume the desired products. • Marginal Utility • The change in total utility resulting from a one-unit increase in the quantity of a good or service consumed. • The Principle of Diminishing Marginal Utility • There may be a diminishing satisfaction per additional unit of the product consumed (the benefit of traveling more than once a year might be diminished due to fatigue and other factors)

23. Currency Exchange Rates • Currency exchange rate • the price of one currency in terms of another • Usually floating, with their values determined by demand for, and supply of currencies in the global marketplace • Appreciation • an increase in the value of a currency • Depreciation • a decrease in the value of a currency • Types of Floating Exchange Rates • Free float • Currency exchange rate is determined by the intersection of demand for (out-payment) and supply (in-payment) foreign currencies • Shifts daily • Fixed float • Government intercedes in the market to influence the exchange rate, by buying or selling its own currency • Needs large international reserves

24. Currency Exchange Rates • Increase in exchange rate is termed a revaluation, a decrease is termed a devaluation • Changes in exchange rates can have considerable effects on tourism and economic stability of countries

25. Balance of Payments • Balance of Payments • A record of international transactions • In-payments and out-payments are two parts of the balance of payments statement • In-payment include exports of goods and services, unilateral transfers, and inflow of capital in various forms • Out-payments include imports of goods and services, unilateral transfers, and outflow of capital in various forms. • Official Reserve Transactions Balances are all in-payments minus all private out-payments. • Surplus: in-payments exceed out-payments • Deficit: out-payments exceed in-payments

26. Implications for Tourism • Implications for tourism • When dollar is weak, travelers come to US • When dollar is strong, US travelers go to other countries • Airlines and other travel providers observe exchange rates closely and price their product and services up or down to avoid losing money • Tour operators try to get guarantees from hotels, ground transpiration operators and other travel providers to that in case an exchange rate makes travel more closely, they are protected from price increase. • People tend to travel more when costs go down

27. Tourism Costs • Tourism costs • Too much dependence on tourism is dangerous due to factors such as terrorism, natural disaster, pandemics, social unrest, safety issues, political rivals, religious conflicts, world-wide economic melt-down and others. • Social costs: crime, crowding, traffic, air pollution, real estate prices change, infrastructure development, food prices and the increasing cost of local government services such as police protection and welfare services. • Other social costs include: low wage jobs; employment of illegal immigrants; culture changes due to traveler’s intrusion of different cultures; cost for government rise when immigrants are employed but remit their revenues to their homes abroad. • Cultural changes, such as divorce, drug use, prostitution, crime become more prominent.

28. Tourism Costs • Too Many Tourists? • “Crowding” is partially subjective and is subject to income level, public services available, and total environment as perceived by the tourist • Sometimes tourists are seen as invaders • Sometimes issues perceived to be the fault of tourists are due to political corruption or changes in human interactions

29. Comparative Advantage • Comparative Advantage • There are differences in opportunity costs between various parts of the world, cities, regions, and nations. • A place has a comparative advantage in producing a particular good and can produce that good at a lower opportunity cost than competitors. • Opportunity cost of any action is the best alternative foregone. For some, there is no best alternative, so the opportunity cost can be zero or negligible.

30. Comparative Advantage • Comparative Advantage • Many developing countries have arrived at this conclusion and turn to tourism to provide jobs, taxes, and revenue. • Transportation, culture, climate, and marketing skill are part of tourisms comparative advantage • Tourism can fit nicely into many economies; it does not have to have it all or have none of it.

31. Cost Benefit Analysis • Cost/benefit analysis • An attempt to quantify and compare the pros and cons of a tourism or other venture. • Focus is placed on: • Economic costs and benefits • Psychological costs and benefits • Sociological costs and benefits • Examples of Pros for Tourism Development: • Increased revenues, tax base, and jobs • More classrooms, hospital beds • Increase in status for some residents • Increase in restaurants, and entertainment choices • Training for youth

32. Cost Benefit Analysis • Examples of Cons against Tourism Development: • Increased cost of social services • More roads, bureaucracy, police, and fire services • Loss of status for some residents • Increase in crime and prostitution • Tourism and its perceived costs or benefits cannot be quantified easily and manipulated into an economic model. • The quantitative models need to have descriptive elements in order to tie them into economic reality.