Commissions Cut
Subject Joint profit maximization, bilateral monopoly
Topic Oligopoly
Key Words Commission, price, cost, consumer, collusion, antitrust, collective bargaining
News Story

Most major airlines have reduced the maximum commission they will pay travel agents to sell air tickets. They will pay 5 percent of the price, subject to a maximum of $20, down from $50. This is the fifth cut in commission in the last six years. In 1995, travel agents earned $3.7 billion in commissions, while selling $56.3 billion in tickets. In 2000, commissions fell to only $2.1 billion, although ticket sales rose to $76.6 billion. The recent change has been prompted by reduced business travel and the largest losses in a decade.

Travel agents are angry. They expect to lose another $500 million unless they can pass the cost on to the consumer. They feel the airlines are trying to put them out of business. As a result, the American Society of Travel Agents asked its members to close for two hours one day in protest. Some agents picketed airports. The airlines deny any wrongdoing. They say that the lower commissions were determined separately by each airline, not jointly, which would constitute illegal collusion.

Although travel agents sell 80 percent of airline tickets, they have no say in what commission they receive. Therefore, they would like to be exempted from antitrust prosecution so that they can engage in collective bargaining with the airlines over commissions.

(Updated October 1, 2001)

1. Most airlines reduced commissions, but they deny any collusion occurred.
a) If true, how do you explain this common step?
b) Is it illegal? Explain.
2. The airlines are facing higher costs than before.
a) Draw a diagram showing the joint-profit maximizing equilibrium of the airlines. Be sure to include the demand and marginal revenue curves and the marginal and average total cost curves. Mark the price received by airlines and the quantity of tickets sold.
b) Show how higher input costs have affected the equilibrium price and output. Explain how this is consistent with a reduction in commissions paid to travel agents.
3. Travel agents want the ability to bargain collectively with the airlines over commissions.
a) What bargaining power do travel agents have?
b) What would be the minimum ticket price that the airlines would accept in the long run?
c) What would happen to the quantity of tickets sold if there was bargaining over commissions? Explain your answer by referring to your diagram.
Source Marilyn Adams, "Travel agents demonstrate against airlines' fee cuts," USA Today, August 31, 2001.

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