Question

Consider a monopolistic airline facing a usual downward-sloping demand curve and choosing the number of passengers served to maximize its profit. The airline also considers a network choice between the fully-connected network (FC) and the hub-and-spoke network (HS). Explain your answer.

Discuss pros and cons of each respective network type from the view of the airline. For what reason, HS (and FC) would be more (or less) advantageous?

Answer 1

In this case, the monopolistic airline is the only airline company or carrier operating in the airlines market and faces a downward sloping market demand curve. In addition, the airlines also provides a network service to the passengers with the options of fully connected network or FC and the hub and spoke network or HS according to the preference of the individual passengers. Now, in this case, the profit-maximizing number of passenger chosen by the airlines theoretically correspond to the equality between the marginal cost and marginal revenue of operation for the airlines and the additional network service for the passengers essentially implies that the airlines can exploit the maximum willingness to pay of the passengers to pay for both of these services and avail them accordingly. Thereofore, it would be beneficial for the airlines to obtain a clear overview or information about the maximum willingness to pay of the consumers preferring to subscribe to both types of network services and charge an additional service fee to each passenger on the basis of the service chosen by them. Hence, by charging service fees to each individual passenger for the respective network services the monopoly airlines can essentially extract the consumer surplus of each passenger aside from the regular or base airlines fair that would maximize its profit. Now, the effectiveness of the service network plan offered by the airlines company ideally depends on the the maximum willingness to pay by the passengers for these services nd the information available to the airlines regarding the same so that the service fee can be set or established by the airlines for individual passengers. Furthermore, the economic or commercial effectiveness of the additional service plan to the airlines. In this context, if the price elasticity of demand of the passengers in the airlines market is relatively inelastic then the passengers would be relative insensitive or unresponsive towards the service fee charged to them and would consequently and expectedly have a higher willingness to pay for both the services resulting in higher revenue generation for the airlines from providing the network services. On the other hand, a relatively elastic price elasticity of demand in the airlines market indicate that passengers would be relatively more sensitive or responsive towards the services fees or charges and hence, would not have much high maximum willingness to pay for the respective services. In this case, the airlines can face passenger withdrawal or rejection for the additional connection network service if the service fee is excessively high.