Firms & Decisions Tutorial - CSQ1 - The airline industry

(a)(i) With reference to Table 2, identify an example of fixed cost and explain your choice

Answer explanation

Try to recall the definition of "fixed cost", does it vary with output level in the short run? What is the output that the airline industry produce?

(a)(ii) With reference to Table 2, identify an example of variable cost and explain your choice. [2]

Please choose all the correct answers below:

• The catering fee is a variable cost because it varies with situations that the airline industry faces.

• The costs on aircraft fuel and oil are variable costs because to provide more flights, the airline companies need to buy more fuel to fly the planes.

• The flight crew salary expenses are variable costs because to attract more pilots, the airline company needs to offer them higher wages.

• The flight crew salary expenses are variable costs because to produce more flights, the airline company needs to hire more pilots and incur higher wage bills.

Answer explanation

Variable costs are costs that vary with output levels in the short run. To produce more output, more variable FOPs are needed, hence higher variable costs are incurred.

(b) Calculate the airline’s profit per flight if all seats are sold. [2]

Please input your calculated result below (in UK pounds). Please input your results without the units.

Answer explanation

In the actual case study, you will need to show workings of your calculation to earn the full [2]m.

[1]m for showing working

[1]m for having the correct answer

(c)(i) Using Table 2, explain two possible cost advantages

of being a large airline company such as British Airways. [4]

Which of the following statements is correct about this question?

• I should explain two types of external EOS for this question.

• I should explain two types of internal EOS for this question.

• I should explain two reasons for why large companies will face lower total costs due to their size.

• I should explain two reasons for why large companies can have higher demand and hence revenue to cover their costs.

Answer explanation

The phrasing "cost advantages of being a large company" is a very typical hint for internal EOS questions, where a firm, due to its large size, enjoys lower LRAC.

Questions with similar phrasings usually require you to consider EOS.

(c)(i) Using Table 2, explain two possible cost advantages

of being a large airline company such as British Airways. [4]

Which of the following internal EOS are possible for this question?

• Technical iEOS

• Marketing iEOS

• Financial iEOS

Answer explanation

All the three choices are possible. You will need to find the two that you are more comfortable with explaining.

(c)(ii) Explain why despite the cost advantages of being large, there are smaller airline companies such as Ryanair which manage to keep costs low. [4]

Ideally, how many reason(s) should you explain for this [4]m question?

• 1

• 2

• 4

Answer explanation

Considering the similar requirement and mark allocation for (c)(i), you should try to offer two possible reasons for why small companies can keep costs low

(c)(ii) Explain why despite the cost advantages of being large, there are smaller airline companies such as Ryanair which manage to keep costs low. [4]

Type out your answers for this question here.

(d)(i) Using the concept of price elasticity of demand, account for the relative price levels of economy and business class tickets. [4]

Which of the following statements are correct?

• PED for economy class tickets

  <

  PED for business class tickets

• PED for economy class tickets

  >

  PED for business class tickets

• The airline company can afford to charge a higher price for business class because the tickets are a smaller proportion of the business travellers' income

• Economy class travellers usually have longer time to search for alternatives than business travellers, making economy class tickets' demand more price elastic

Answer explanation

The business class tickets are two times more expensive than economy class tickets. [1]

The airline companies can afford to charge a higher price for business class than for economy class because the demand for business class tickets is more price inelastic than that for economy class tickets. [1]

This is because [explain one PED determinant out of SHIT], hence, charging a higher price for business class will not reduce TR due to the less than prop fall in Qd. [2]

(d)(ii) With reference to Extract 1, explain two possible reasons why air ticket prices have fallen for British Airways. [4]

Which of the following statement(s) are the most correct for this question?

• I should explain why the DD is falling and the SS is rising, leading to price falling.

• I should explain two reasons for why British Airways is setting lower prices at the profit-maximising output level.

• I should explain one reason for falling revenue and one reason for rising costs for British Airways.

• I should use DD/SS framework and diagram for this question.

• I should use firm's profit max diagram for this question.

Answer explanation

The question is on why air ticket price for ONE SINGLE airline company, British Airways (BA), is falling.

Based on Ext 1, the airline industry is likely oligopolistic in nature where BA has significant market share in some routes (e.g., 43% market share of the London to Sydney service if BA merges with Qantas). Thus, BA is a price SETTER who charges its own profit max prices.

Thus, firm's analysis should be used for this question where the DD/AR for BA (as a single firm) is falling and the variable cost on oil is also falling (leading to falling AC and MC) for BA.