Question

1.   State the six principles of economics. Then read case number below, and explain how it illustrates each of the six principles of economics.

If you owned shares of the Priceline Group, the online provider of travel-related reservations and search services, in fall 2015, you would have been one happy camper. That is when its price per share hit an all time high of over US$1,400, resulting in a company valuation of over US$73 billion dollars.

Even more remarkable is the fact that in 2002, the company was in such deep trouble that many doubted it would survive. From 1999 to 2002, Priceline lost 95% of its value, going from a company valuation of US$9 billion to a paltry US$425 million. What went so right, then so terribly wrong, and then so incredibly right again at Priceline?

When the company (originally Priceline.com) was formed in 1998, investors were immediately impressed by how it revolutionized the travel industry. Its success lay in its ability to spot exploitable opportunities for itself and its customers. The company understood that when a plane departs with empty seats or a hotel has empty beds, there is a cost—the revenue that would have been earned if the seat or bed were filled. Priceline’s innovation was to bring airlines and hotels with unsold capacity together with travellers.

It works this way: customers specify the price they are willing to pay for a given trip or hotel, and then Priceline presents them with a list of options from airlines or hotels that are willing to accept that price. Typically, price declines as the trip date nears. Although some travellers like the security of booking their trips well in advance and are willing to pay for that, others are quite happy to wait until the last minute, and risk not getting their first choice flight or hotel in order to benefit from a lower price.

Priceline, then, found a way to make everyone better off—including itself, since it charged a small fee for each trade it facilitated.

Yet, in 2002 the company was at risk of going under. After the terrorist attacks of September 11, 2001, many Canadians simply stopped flying. As the economy went into a deep slump, airplanes sat empty on the tarmac and the airlines lost billions of dollars. Several major airlines spiralled toward bankruptcy, and Priceline was losing several million dollars a year.

In order to avert a meltdown of the airline industry, the U.S. Congress passed a US$15 billion aid package that was critical in stabilizing the industry. It was the seed of Priceline’s turnaround. The company managed to survive and eventually thrive.

Quick on its feet when it saw its market challenged by newcomers Expedia and Orbitz, it responded aggressively by moving more of its business toward hotel bookings and into Europe, where the online travel industry was still quite small. Its network was particularly valuable in the European hotel market, composed of many more small hotels compared to the North American market, which is dominated by nationwide chains. The efforts paid off, and by 2003 Priceline was turning a profit. From 2005 to 2014, Priceline.com expanded by acquiring the travel websites Booking.com, KAYAK, agoda.com, rentalcars.com, and OpenTable, transforming itself into the Priceline Group, with revenue of US$10 billion in 2016.

Answer 1

Answer:

The seven economic principles are as under:

1. Scarcity forces trade-offs:

From the above case we see that 'when a plane departs with empty seats or a hotel has empty beds, there is a cost—the revenue that would have been earned if the seat or bed were filled'. This shows that lack (scarcity) of customers forced airlines & hotels to lower prices (trade-off).

2. Trade makes people better off:

Hotels & airlines traded their products (unsold seats/capacity) with Priceline, which in turn traded this information with prospective customers for a fee. Thus, trade made all parties better off than before.

3. Markets Coordinate Trade: 

Market is any place where buyers and sellers come together, either in a store or online. Priceline - the online provider of travel related reservations and search services - brought prospective customers & airlines/hotels (sellers) together on its portal.

4. Costs versus benefits:

By allowing 'customers to specify the price they are willing to pay for a given trip or hotel, and then Priceline presenting them with a list of options from airlines or hotels that are willing to accept that price', Priceline gave its customers the opportunity to do a cost-benefit analysis.

5. Thinking on the Margin:

Since 'price declines as the trip date nears', customers have to think about what they gain (in terms of lower price vis-a-vis their choice of hotel/airline), by either waiting/not waiting that additional day/week before booking.

6. Incentives Matter:

Since some customers 'are quite happy to wait until the last minute, and risk not getting their first choice flight or hotel in order to benefit from a lower price, this shows that the incentive (of a lower price) motivates people to wait longer before booking.

7. Future Consequences Count:

When countered with the threat of newcomers, Priceline's decision of 'moving more of its business toward hotel bookings and into Europe, where the online travel industry was still quite small' paid off handsomely & its value blossomed.