Problem Set 7 Key r 6 -16
1. Between 1995 and 1997, American Airlines competed with several low-cost-carriers on routes from Dallas/Fort Worth. The US Department of Justice sued alleging predatory pricing. A judge disagreed. Read this article from the Wall Street Journal (available through the Hunt Library ProQuest database):
Wilke, J. R., & McCartney, S. (2001, April 30). American Airlines secures antitrust win — Judge dismisses U.S. case, says competitive moves were company’s right. Wall Street Journal (Eastern edition), pp. A.3.
The antitrust legal standard for predatory pricing is pricing below variable or marginal cost. Discuss why the plaintiffs lost this case in the face of what most lay people would consider predatory pricing. Hint: Consider how to compute marginal cost for an airline.
2. The archetypal low-cost-airline operates a point-to-point route structure with no passenger connections available to other flights in the LCC’s route system. If an LCC is operating a 150 seat aircraft in city-pair A-B, how many passengers must be bound for B to achieve an 80% load factor (don’t overthink this, it’s easy!)?
3. Most large airlines operate networks, or hub-and-spoke systems, which connect many spoke cities (or nodes) with flights to and from a hub airport.
a. A network carrier serves 39 spoke cities from a single hub. How many city-pairs does it serve? (A city-pair is City A to City B. City A to City B and City B to City A are consider just one city-pair)
b. This same airline adds a 40th spoke city to its network serving the city with a 100 seat capacity aircraft. Consider the morning flight from this new spoke city to the hub. How many passengers on average does the airline need to attract to each of the possible network destinations to achieve an 80% load factor on this flight?
c. How can a network airline profitably serve smaller cities than a low-cost-airline? (Hint: Consider 2b above).
d. A network carrier serves some small cities close to its hub with regional jets which have much higher seat-mile-costs (CASM) than larger mainline jets. The average fare from these cities to the hub does not cover fully allocated costs. Is this rational?
e. Networks are subject to negative externalities. How might such externalities affect a network carrier’s decision to add another spoke city to its network? Explain. (You may wish to use marginal benefit/cost analysis).
4. In the early 1990s, Airbus and Boeing were both considering building a new Very Large Aircraft (VLA). Airbus faced this decision tree. Boeing’s decision was similar. Why did only Airbus build the VLA, the A-380? “A” in the decision tree is Airbus and “B” is Boeing. “Build” indicates the decision to build the VLA and enter the marketplace. Similarly, “Don’t Build” is a decision not to build a VLA and not to enter the marketplace. The numbers in parentheses indicate the 20 years incremental profit in billions of dollars for Airbus and Boeing.