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    Profit Maximizing in the Market for Air Travel

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    Formerly, the market for air travel within Europe was highly regulated. Entry of new airlines was severely restricted, and air fares were set by regulation. Partly as a result, European air fares were higher than U.S. fares for routes of comparable distance. Suppose that, for a given European air route (say, London to Rome), annual air travel demand is estimated to be

    Q = 1,500 - 3P (or equivalently, P = 500 - Q/3)

    where Q is the number of trips in thousands and P is the one-way fare in dollars. (For example, 600 thousands annual trips are taken when the fare is $300.) In addition, the long-run average (one-way) cost per passenger along this route is estimated to be $200 (Note that in this case, average cost is the same as marginal cost).

    a. Some economists have suggested that during the 1980s and 1990s there was an implicit cartel among European air carriers whereby the airlines charged monopoly fares under the shield of regulation. Given the preceding facts, find the profit-maximizing fare and the annual number of passenger trips.

    b. In the last 10 years, deregulation has been the norm in the European market, and this has spurred new entry and competition from discount air carriers such as Ryan Air and EasyJet. Find the price and quantity for the European air route if perfect competition becomes the norm.

    c. Given your results in parts (a) and (b), explain why society dislikes monopoly.

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    Solution Preview

    a) In a monopoly market, the profit-maximizing point is where Marginal Revenue (MR) = Marginal Cost (MC).

    We are told that MC = 200

    To find MR, first find Total Revenue (TR):
    TR = PQ
    TR = (500 - Q/3)Q
    TR = 500Q - (Q^2)/3

    MR is the ...

    Solution Summary

    This solution uses mathematical analysis to calculate the equilibrium fare and number of trips under both monopoly and perfect competition. The results show why society dislikes monopoly.