Intermediate Microeconomics and Its Application 12th Edition by Walter Nicholson,Christopher Snyder

Exercise 8

Jet Fuel and Hybrid Seeds
Although our discussion of input demand uses generic references to "capital" and "labor," the theory applies to any input that firms use. Here we look at two more narrowly defined inputs and show that the marginal productivity theory has relevance to them as well.
Jet Fuel
The price of fuel of jet planes has fluctuated widely over the past 40 years. For example, between 1970 and 1980, prices increased more than sevenfold and fuel costs rose from 13 percent to nearly 30 percent of airline costs. After 1980, however, fuel costs began a slow decline, dropping more than 42 percent by 1999. In 2000, fuel costs made up only about 12 percent of airline costs. After 2002, fuel costs for airlines rose rapidly again, nearly tripling by mid-2008. After a brief period of declining prices in 2009, fuel costs continued their upward trend. By 2013 fuel costs constituted nearly 35 percent of airline operating costs.
Adapting to these trends has posed problems for many airlines. Of course, in the short run, there is very little that the firms can do in response to these changing fuel costs. They must fly the fleets of planes they have and these have relatively fixed demands for fuel. Over the longer term, airline firms can adapt their fleets to prevailing fuel prices, but because bringing on new aircraft takes a long time, it is easy to lag behind market realities. For example, during the early 1980s, airlines improved their fuel economy dramatically as firms responded to the earlier sharp increases in price by purchasing fuel-efficient planes. Passenger miles per gallon of fuel nearly doubled. This trend slowed dramatically in the 1990s, as fuel costs stayed low and airlines paid much more attention to labor and other operating costs. The increases in fuel costs after 2002 therefore caught many airlines by surprise. Although a few (most notably Southwest) had hedged their fuel expenses by purchasing forward contracts, most airlines faced cost increases of as much as 50 percent. Again, in the short run there was little that the airlines could do to economize on fuel other than, for example, shutting off their engines while taxiing. Over the longer run, however, airlines are investing in lighter planes (such as the Boeing 787) and more efficient jet engines that offer significant savings in fuel costs.
Hybrid Seeds
Hybrid seeds for growing corn were developed during the 1930s. In the ensuing decades, the use of this newly invented "input" spread throughout the world. The econometrician Zvi Griliches looked in detail at the decisions by U.S. farmers to adopt these seeds.2 In this seminal work on the economics of technical change, he showed that such decisions were motivated primarily by farmers' profitability calculations. In states where farmers could expect large increases in yields from adopting hybrids (in Iowa, for example), adoptions came about rapidly. Adoptions proceeded much more slowly in states such as Alabama where weather and soil conditions were not especially favorable for hybrids.
More recent studies of the spread of hybrids throughout the world reach similar conclusions. In nations where the hybrids are highly profitable (India) these seeds have been widely adopted and yields have expanded dramatically. Similar quick adoptions occurred throughout much of Southeast Asia. This "Green Revolution" did not have such a major impact in places such as western Africa, however, where drier climates and rigid price controls on agricultural output sharply reduced the profitability of hybrid adoptions.
How are airlines' reactions to changing fuel prices affected by the types of planes they own and by the kinds of routes they fly? Would owning a variety of types of planes help to make such adjustments in the short run? What would be the disadvantages of flying many types of aircraft? If you look around an airport, does it seem that different airlines take differing approaches to this question? Can you explain why?