Key concepts: applied economics of costs

The concept of costs in the airline industry is most often mentioned in the press in light of the distinction between “low-cost” and “non-low-cost” or “full service” carriers (LCCs versus FSCs). What is often implied in these discussions is that low-cost carriers tend to offer cheaper tickets as compared to the full service airlines (a contention I will revisit in this chapter), while offering fewer amenities to their passengers. Indeed, if we look at conventional cost metrics, such as cost per available seat mile (CASM), which is calculated by simply dividing the airline's total cost of operation over a certain period by available seat miles or the product of number of seats offered and the number of miles flown, we will see that there appears to be a gap between carriers referred to as LCCs and those known as FSCs. For instance, in 2019 a leading LCC on the US market, Southwest Airlines, boasted CASM of 12.23 cents; the same measure for American Airlines was 17.16 cents, while for Delta Air Lines it was equal to 16.16 cents (see Table 2.1 for further figures). However, can we draw a line in this measure to say that all airlines with CASM below a certain threshold are low-cost carriers, whereas carriers with higher values are FSCs? Or, do airlines’ costs depend at least in part on the carriers’ business strategies and may therefore not always be directly comparable?

The key economics concepts that relate to costs and which are relevant to understanding what is behind these differences in CASM across airlines are as follows. First, we can generally divide the operating costs into those that do not depend on the output level (so-called fixed costs) and those that vary as the output changes (known in economics as variable costs). Second, costs can grow as fast as, faster than, or slower than the output (this concept is known as economies of scale). Finally, firms can and do invest in provision of higher product quality, inevitably resulting in higher costs of operation. Such investments are done by airlines to attract price-insensitive business travellers, and increase their revenues.