Risk Assessment Affects Air Prices?

Richard and James have been having a little chat about the openness of information in markets and how this affects prices. This caused me to wonder about the recent alleged terrorist threat in the UK, and how this would affect plane ticket prices. The commonly accepted wisdom seems to be that there was a terrorist threat, that a certain amount of it still persists, and will continue to do so for the foreseeable future. The current restrictions on carrying liquids on planes are also a serious inconvienience for people who do a significant amount of air travel.

That liquids are banned is (hopefully) an incontrovertible fact, and I’d be surprised if this didn’t have an affect on demand for flights, and thus presumably prices, as airlines become more desperate to attract customers. The extent to which the terrorism threat exists is more debatable. If the commonly accepted wisdom is correct, people are likely to cut back on the amount of air travel they do (human beings are notoriously bad at assessing risk so it’s hard to know whether this is rational). However, if it is incorrect (let’s take the extreme example where there is no terrorist threat and the allegations are wrong, whether malicious or mistaken), this will still happen, and we can still expect prices to fall - because most people still believe the accepted wisdom. What this means is that if you don’t believe in the threat, you’re getting ticket prices cheaper than you otherwise would do - because there is distortion in the market on a grand scale. This would be an example of market failure because of faulty information, and is a longer-term variant on the problem James was alluding to with the discontinued component. Normally market failure is identified when there is information asymmetry between the buyer and the seller, but I believe inconsistent information between buyers could be another potential cause (I’d be interested in comments from those more qualified in economics than I).

I’m not making judgements about the likelihood of any particular situation (although I do have opinions that I’ve discussed in other posts). I do think this is a good example, though, of how centralised information dissemination can influence a market.

Comments

Thanks for your comments. I wasn't familiar with Coase theorem, so took a look at the Wikipedia article: http://en.wikipedia.org/wiki/Coase_theorem and I'm not entirely certain I understand its relevance here. Is it possible you could clarify for me? My original point (and maybe I didn't make it clearly) was that if 95% of the buyers in the market believed the 'wrong' thing, and 5% believed the 'right' thing, the market price was still determined by the 95%. So the price paid by those who are 'right' doesn't reflect an accurate valuation of the goods (i.e. in this case, it accounts for danger that perhaps isn't present). I have realised, though, that I ignored increased security fees etc. that will no doubt be levied by airports/airlines/government - I don't know what effect they will have.
I think you will find that Coase theorum shall prevail. No, it is not a typo for chaos theory. Yes, now you will need to look it up...