Question

Suppose that you are the CEO of a discount airline that caters to students on tight budgets who want to travel to warm locations when the weather gets cold. Currently, your airline flies small regional jets from the MBS International Airport to 6 cities in Florida. Assume that your airline has a monopoly on the local market.

1. List the conditions that apply to monopolies, and briefly describe how they apply to this airline. (6 points)
2. Using the table below, determine the profit maximizing number of passengers that you should serve out of the MBS market. The price is for a round-trip ticket. (8 points)

P	Q	TR	MC
500	100	50,000	60,000
450	200	90,000	70,000
400	300	120,000	80,000
350	400	140,000	90,000
300	500	150,000	100,000
250	600	150,000	110,000
200	700	140,000	120,000
150	800	120,000	130,000
100	900	90,000	140,000
50	1,000	50,000	150,000

3. Suppose that your fixed costs are $50,000, and your variable costs are $100 per passenger. Would you ever consider shutting down the airline? At what point would you do this and why? (8 points)

3. Suppose that your airline was competing with 3 other airlines for the passengers wanting to fly to Florida. How would you determine what fare to charge? Would you collude with your competitors? Why or why not? (8 points)

Answer 1

P	Q	TR	TC	MR	MC	MR-MC
500	100	50000	60000	-	-	-
450	200	90000	70000	400	100	300
400	300	120000	80000	300	100	200
350	400	140000	90000	200	100	100
300	500	150000	100000	100	100	0
250	600	150000	110000	0	100	-100
200	700	140000	120000	-100	100	-200
150	800	120000	130000	-200	100	-300
100	900	90000	140000	-300	100	-400
50	1000	50000	150000	-400	100	-500

Profit is maximized when MR-MC=0

So, At max profit: P= 300, Q=500

2. Airline shutdown will be considered only if P<ATC => when P< 50000+100Q

Below this value of P, there will be losses and it will not be viable to run. So, price should be higher. Being a monopoly, it wont be a problem as price can be increased for fixed costs.

3. fare can be found using the cournot competition problem where a best response function pertaining to prices charged by other airlines can be used to find the correct price. collusion wont be beneficial as some airline will always have incentive to lower the cost and polarize the entire market, so cartel or any collusion wont be stable.