South-Western College Publishing - Economics  
American Airlines' Tactics Alleged To Be Un-American
Subject Anti-trust regulation
Topic Government and the Economy
Key Words Antitrust, Predatory Pricing, Competition, Fares, Government, Short Run, Monopoly, Losses
News Story

The Federal Government is bringing an antitrust case against American Airlines alleging that the airline engaged in predatory pricing to thwart competition at the Dallas-Fort Worth airport. This coincides with growing consumer complaints about fares and service and congressional discussion about measures to disclose more information about fares and delays and to compensate travelers for inconveniences.

The government believes that American reduced its fares below cost, and added new flights, losing money in the short run. By forcing low-cost competitors out of the market, American was able to restore its monopoly position at the airport and to recoup its losses many times over. For example, on the Dallas-Wichita route, before the competition American charged $110 on average one-way, and carried 4465 passengers on average per month. When it competed with the low-cost carrier Vanguard, it lowered the fare to $57 and carried 11,246 passengers per month. Two months later, Vanguard abandoned its plans to expand, and American increased its fare to $96 and reduced the number of passengers to 8,540.

The airline responds that it should not be found guilty since it was only trying to match fares.

(Updated July 1, 1999)

Questions
1. American had a monopoly on the Dallas-Wichita route. Draw a diagram of American's monopoly position, showing the demand and marginal revenue curves, and the marginal and average total cost curves.
  a)Mark the initial equilibrium price of $110 and the equilibrium quantity of 4,465 passengers a month. Show the profit being made at the time.
  b)When Vanguard increased its low-cost service, what would you have expected to happen to American's demand curve? What would have happened to the equilibrium price, output and profit? Illustrate on your diagram.
  c)How does this compare with what American actually did?
2. During the competitive phase, American is alleged to have reduced its price below marginal cost.
  a)Draw a second diagram of American's monopoly position and show the airline charging below marginal cost at a disequilibrium price of $57 on average, and carrying 11,246 passengers a month. Show the loss earned.
  b)How do you think American was able to persist with making such losses while Vanguard was forced to scale back?
3. After the monopoly was restored, American raised its fares to $96 and carried only 8,540 passengers.
  a)Why do you think it did not raise its fares back up to $110?
  b)Explain why predatory pricing was a worthwhile investment for American.
  c)What do you think of American's defense? Why?
Source Stephen Labaton with Laurence Zuckerman, "Airline Is Accused Of Illegal Pricing," New York Times, May 14, 1999.

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