Question

The Boeing CEO recently predicted that a major US airline would go out of business before the end of the year. Please analyze the change in demand and result that is occurring in the airline industry today.

(a) Graph and explain this as if it were a perfectly competitive increasing cost industry, with the industry graph on the left and the individual firm on the right.

(b) Have the industry start in long-run equilibrium (at points A and a) and move to points B and b with a decrease in demand.

(c) Finally, have the industry go back to long-run equilibrium at points C and c.

i. At each of these points explain how and why price and output are changing in the industry and with each individual firm.

ii. How can you tell when point C is reached?

Answer 1

Ans.

a) Suppose the market starts in long run equilibrium where industry output is Q and price is P. As the industry is competitive, so, airlines are a price taker. So, quantity supplied by individual airline is q.

b) After the decrease in demand, industry demand curve curve shifts to left to D’ from D. This decrease the quantity in the industry to Q’ from Q and price from P to P’. This decreases individual equilibrium quantity to q’ which brings down the individual airline’s equilibrium output below the average cost.

c) As price is now below the average variable costs, so, airlines start incurring losses and not able to cover even its variable costs which make some of them to exit the market. This decreases the supply of tickets in the industry increasing the price level back to level P and quantity decreases further to Y”. This brings the airlines industry back to long run equilibrium where some airlines have shutdown.

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