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TOURISM SUPPLY 1. The Decision to Supply

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1 TOURISM SUPPLY 1. The Decision to Supply
2. Time Frames in Tourism Supply 3. Production Functions and Inputs 4. Programming Approaches 5. An Example of Linear Programming 6. Costs and the general nature of supply 7. Elasticity of Supply 8. Inelastic Supply and Economic Rent 9. Factors Shifting Supply Schedules

2 1. The decision to supply The act of supply requires the willingness and ability of an enterprise > to acquire resources, and > to process those resources into an output of products for sale

3 1. The decision to supply Main barriers to entry in tourism industry are: > A significant capital requirement for some sectors > Government requirements for enterprises to hold licenses or bonds > Competitive reaction from existing enterprises > Planning or other restrictions on resource use for tourism by governments > The need for ‘know-how’

4 1. The decision to supply An enterprise must address the questions:
> Exactly what product or products will be produced? > Where will it be produced? > When will it be produced? > How will it be produced? (with what combination of resources and by what process method?)

5 1. The decision to supply Since many entrepreneurs consider themselves not as producers of a ‘tourism product’ but as working within some different sector, their supply responses and production decision making may be influenced more by factors other than ‘tourism industry’ ones. This means that the supply response within tourism as a whole is rarely homogeneous, except in relation to factors which influence an entire economy.

6 2. Time frames in tourism supply
The short-run can be roughly identified as a period within which the level or scale of use of most of an enterprise’s resources, or factors of production, is fixed assets are those whose input level is least variable. What is considered to be short-run varies between different types of enterprise in tourism

7 2. Time frames in tourism supply
At one extreme the tour-guide co-operative can adjust the scale of production of its services very quickly – with little capital or land requirement. At the other extreme an airport authority may have to wait years for an expansion, as might an airline wait for the delivery of new aircraft. Most static supply analysis relates to short-run situations.

8 3. Production functions and inputs
Classical production theory suggests that an enterprise can produce a level of output Q from alternative combinations of inputs. The relationship of production is expressed as: Q = f (N, C, L) The increases in inputs used for produce goods and services leads increases in the level of total output.

9 3. Production functions and inputs
In practice there may be more than those three inputs in order for production from x to xn. For this reason, production function can be expressed as; Q = f (x1, x xn)

10 3. Production functions and inputs
Productivity of input i is expressed as the derivative dQ/dx1 where all inputs other than i are held constant. The best example of the ability to vary productivity in tourism is probably that of labor within a F&B operation. Secondly, a given amount of output Q may theoretically be produced from varying combinations of inputs. The alternative combinations, when graphed, are referred to as isoquants. The optimum combination at any particular time relates to the comparative costs of inputs x xn in such a way that the minimum total cost combination (isocost) should be obtained.

11 3. Production functions and inputs
There are severe difficulties in applying this analysis to individual enterprises in tourism industry short-term because most tourism production involves fixed short-run relationships between inputs. It is only in the long-run that substitution for inputs becomes more important.

12 6. Costs and the general nature of supply in tourism
Basic economic theory of costs and supply normally assumes that > goods are being produced, and > there is a rough equivalence between fixed and variable costs over a given period.

13 6. Costs and the general nature of supply in tourism
* These assumptions are not valid in tourism industry > Most products are services, and most of those services involve the consuming tourist physically going to the producer’s ‘plant’; that plant therefore has to exist and operate in many cases regardless of the number of tourists provided for, or ‘product units supplied’. > Consequently, a major feature of tourism-supply activity is the heavy influence of fixed costs.

14 Costs in tourism industry FC - SFC (SVC) – VC full capacity

15 6. Costs and the general nature of supply in tourism
Fixed costs (FC) represent a high proportion of total costs. Semivariable costs (SVC) are those ‘lumpy (mass)’ costs which increase with production but not on a unit basis Variable costs (VC) are frequently very small.

16 6. Costs and the general nature of supply in tourism
If output can be sold at the same price throughout (or the same average price to a consistent split of segmented markets), then total revenue (TR) will increase as a straight line; the maximum profit position will be the same as the maximum production and revenue positions, and the enterprise will seek always to supply to its full capacity.

17 6. Costs and the general nature of supply in tourism
If the market price falls for all customers, the optimum supply position is still full capacity, albeit with reduced profits. Example: seasonality in tourism industry. In some seasons tourism enterprises must either accept considerably reduced demand or reduce prices, and hence (TR), to fill capacity. Either way, provided (TR) exceeds (VC + SVC), a contribution is being made to fixed costs, and make its profit, from peak season.

18 6. Costs and the general nature of supply in tourism
Many enterprises will opt for full-capacity utilization for two reasons: 1. The contribution to (FC) is likely to be greater (if TR is considerably less steep but still straight, the maximum contribution is still likely to occur at full output) 2. Continuity of full operation helps to keep staff and maintain high productivity, as well as being a perceived benefit in marketing

19 Costs and revenue - TR1, TR2, TC
Cost / revenue TC Output TR1 TR2 FC VC

20 6. Costs and the general nature of supply in tourism
The line (TR2) is one where lower unit prices are required to get extra customers. Even in this case, the maximum profit position is likely to be full capacity unless the MR obtained from an extra sale is less than VC. This is because the TC function is relatively not very steep - a result of the heavy fixed costs. Therefore, if a hotel manager or airline station manager has a good idea of VCs, he or she should be able to bargain a low price with last minute ‘walk-in’ or ‘stand-by’ customers at a level sufficient to cover (VC) and still improve profitability.

21 6. Costs and the general nature of supply in tourism
Clearly, not all enterprises in tourism industry face the above conditions. Travel agents or NTOs do not have specific capacity constraints, and their willingness to supply will depend more on costs of increased labor necessary to provide extra services. Their cost structure, like that of tourism goods suppliers (producing items such as souvenirs), will tend to produce a more ‘normal’ supply willingness.

22 7. Elasticity of supply tourism industry enterprises aim for operating at full capacity. In the lodging sector, operators refer to their occupancy rate, expressed as a percentage of capacity taken up by the market In travel and transport, the same is true, except that the measure is known as load factor. Many tourism attractions such as theme parks or golf courses measure their usage rate, which they compare with some theoretical optimal visitor capacity.

23 7. Elasticity of supply Most short-run, individual-enterprise supply is extremely inelastic in tourism industry. If market prices are high, supply will be at full capacity, and even if low, there may still be pressure to operate at full capacity. Thus short-run industry supply is also very inelastic. Instead, suppliers will try to adjust demand to equal capacity supply by altering prices or promotion.

24 In the long run, industry supply will be more elastic
In the long run, industry supply will be more elastic. This is accomplished by: > temporary closure out of season, or permanent shutdown. If enterprises are faced with (MR) falling below (MC) or if off-season contribution levels are ‘not worth the effort’ > new entrants to the industry, existing suppliers permanently expanding capacity, or doing so temporarily when market prices are high.

25 7. Elasticity of supply In practice, the temporary measures are usually associated with seasonal market variations. ‘Off-season’ does not normally mean that demand vanishes (dissapear), but demand can only be sustained at much reduced prices. Exception: off-season in skiing areas Permanent change in supply is occasioned more by long-term trends and supplier anticipations.

26 8. Inelastic supply and economic rent
Where supply is essentially fixed, increased demand can only be translated into rationing or higher prices, in which the increased return to the supplier is known as ‘pure economic rent’, (David Ricardo in 1815). The potential for economic rent is high at unique tourism attractions where even long-run supply is fixed. If products are sold commercially or are resalable, economic rent is seen in action. Many such attractions are public goods.

27 9. Factors shifting supply schedules
A wholesale shifting of any supply schedule can be caused by changing market conditions for products in joint or competitive supply. With goods, joint supply normally implies by-products but there are few such cases in tourism . Services are user-specific and rarely contain a by-product element. A version for joint supply only occurs where tourism products are also supplied to non-tourism markets, and the demand is complementary; If conditions in any of these markets change, willingness to supply in the others may be affected. If it is possible to serve all markets within capacity, then the products are virtually joint, but if total demand exceeds capacity, they are products in competitive supply.

28 9. Factors shifting supply schedules
In the short-term, none of these factors affects supply willingness very much because of the inherent (inseparable) inelasticity of supply. However, in the long-run, capacity, and hence supply schedules, will shift.

29 9. Factors shifting supply schedules
Changes in cost, including taxation, work through the same process. In the short run, tourism industry suppliers facing cost increases will not adjust supply, but will > either absorb the increases with reduced profit > or attempt to pass them on in higher market prices, depending on their degree of market price control. Industry-wide cost changes in particular (state ‘bed taxes’, airport taxes) are immediately passed on to consumers.

30 End of slides

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