Airline Elasticity Essay

Submitted By bmunden
Words: 1116
Pages: 5
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Part 1

Part 1 - Questions
a) Based upon the Income Elasticity of Demand calculation, when this number is positive, a good is considered normal. When it is negative, a good is inferior. When income increases, demand also increases. Thus the economy class tickets in the Chicago-Columbus are a normal good.
b) This is answered based upon the Cross Elasticity of Demand equation. When the number is positive in this case, the good is a substitute. Due to United lowering its prices the demand for American’s tickets increased.
c) Per the hint, we must take into consideration as to what will happen to TR and TC if we change our prices. Per the above calculations, the elasticity of demand (own-price) is 3.11. This means if we increase the price by 1% that our number of tickets sold will decrease by approximately 3.11%. If we lower the amount of tickets sold, our revenue will go down. (R = PxQ) Instead, we should lower prices which would increase demand as well as total revenues. As to costs, we can look at the load factor. The plane is not at full capacity so with the increase of demand, there will be marginal costs incurred as each passenger is added such as cleaning and food or beverages.

d) I am going to say larger. Over a longer time frame, it is more elastic. We would have more choices as to substitutes.

e) ed = -3.06 = .30/%ΔP
%ΔP = .30/-3.06 = -9.804%
So, for a 30% increase in quantity, price needs to drop by 9.804%. $109.00 = Original price @ 70% -0.098 = 30% increase in Qty from 70% to 100%, price needs to drop by 9.804% $(10.68) = .098 drop in price from original price of $109.00 $98.32 = Original price - .098 drop in price (10.68)

It would take a price of $98.32 to fill all the seats.

Part 2 – Questions

a) P = R – TC R = P X Q R = $98.32(new price from e above) x 310 = $30,479 TC = FC +VC = 20,000 + (10x217) + (11x93) = 20,000 + 2,170 + 1,023 TC = $23,193 P = R – TC P = 30,479 – 23,193 P = 7,286

American’s profit would be $7,286

b) As long as R > C, American can continue on. Once R < C, then American would go out of business. In the long run, firm can cover all costs. In the short run, firm can continue to operate if it covers its variable costs.

c) P = R – TC R = P X Q R = $98.32(price from e above) x 155 (plane half full) = $15,240 TC = FC +VC = 20,000 + (10x155) = 20,000 + 1,550 TC = $21,550 P = R – TC P = 15,240 – 21,550 P = (6,310)

American’s loss would be ($6,310) for the second flight. In the short run, as long as we can cover our variable costs we can continue to leave pricing where it is. In the above example our profit of $15,240 is greater than our variable costs of $1,550.

d) United is a close substitute of American in regards to the example above. We’ve seen from the cross-price elasticity of demand that when United decreases its prices by 1%, this hurts the demand for American's economy class tickets, which is reduced by more than 2%. If these companies were not close competitors, we would expect the cross-price elasticity to be very close to zero; so that price changes in one company would not affect demand for tickets in the other one. Since this is not happening, we conclude that American and United are close substitutes of each other. United could then lower its prices as long as TR is great then TC.

Part 3 – Questions

1) The industry that I am in pertains to the construction of Substations and Transmission Lines as well as Alternative Energy products. The majority of our work is competitively bid. Our model is such that the majority of our overhead is included in the billing rates that we provide with our bid mechanism. What this does is basically the
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