Question

Suppose Tom’s brother works for an airline as a union representative for the machinists working on the planes. Two years ago, there was a forced landing that severely injured five people on the flight of one of the airline’s passenger planes. While watching television at Tom’s house, he notices his brother is rather depressed. Tom asks him what is wrong. “Remember that crash of Flight 3183 to Buffalo a while back?” the brother asks. Tom shakes his head in the affirmative. “Yeah. You were worried whether or not it would be blamed on your workers for a mechanical failure.” The brother sighs. “Well, we got word today that the NTSB is going to find that one of my guys was at fault. They’re going to announce their findings by the end of the week.” Tom nods while returning his attention to the television. The next day, Tom picks up the phone to call his broker, selling all the shares he has in the airline. Using supply/demand analysis, what would we expect to happen to the share price of the airline once the NTSB announcement is made that the airline was at fault? Ethically, should Tom have reacted the way he did? Discuss.

Answer 1

Using supply and demand analysis, i would expect the share price of the airline to fall once the NTSB announcement is made that the airline was at fault. This is because, investors will start to sell the shares of the airline and the demand for the airlines shares would decrease. I have explained this with the help of a diagram below.

In the diagram below, Price is taken on the vertical axis and the Quantity is taken on the horizontal axis. The initial demand was the Demand curve and the final demand was the Demand1 curve. The supply of shares would remain unchaged at Supply curve. When the demand decreases, the equilibrium price falls from P to P1 and the equilibrium quantity also falls from Q to Q1. This means that the share price of the airline would fall.

Ethically, Tom should not have reacted the way he did because Tom used inside information of his brother who knew the situation before and used that information for the trading of shares. Using inside information for trading of shares of not ethically right.