European Airlines: Too Many For Their Own Good?
Subject Comparative statics
Topic Monopoly
Key Words Losses, laid off, consolidation, profit margins, costs, pay increases, customer desertion, foreign ownership, cost-savings, mergers
News Story

In the week after the September 11 hijackings, traffic on U.S. airlines fell 35 percent, while that on other carriers fell 20-25 percent. Widespread losses are expected. Swissair and Sabena face collapse. About 120,000 workers have already been laid off.
The U.S. government has promised $15 billion to carriers to offset the closure of U.S. airspace for 4 days. However, the European Commission does not want governments to forestall what it sees as a necessary consolidation of airlines. Profit margins average only 3 percent worldwide. Costs are high. Companies are capital intensive, so when revenues recede, costs continue. Airlines have been willing to concede generous pay increases to groups, especially pilots, to avoid customer desertion.
Government is also to blame. Each wants a national airline as a matter of pride. There are limits on foreign ownership that prevent the cost-savings that result from mergers. When times are hard, governments tend to bail the airlines out.

(Updated November 1, 2001)

1. Draw a diagram of a European airline that approximates a monopoly. Include the demand and marginal revenue and average total and marginal cost curves.
a. Show the initial profit-maximizing equilibrium fare and traffic of the airline.
b. Show the effect of the September 11 hijackings on the equilibrium fare and amount of traffic, and the resultant profit.
c. Add an average variable cost curve such that there are high fixed costs. Explain why you have drawn the curve as you have.
d. What are the major advantages and disadvantages of high fixed costs?
e. Can a monopoly airline go out of business? Explain.
2. Draw another diagram of a European monopoly airline.
a. Show the effect of pay increases for pilots on the equilibrium fare and amount of traffic.
b. Why is this preferable to a strike and a loss of customers?
3.. If some European airlines were to merge,
a. What economies of scale would result?
b. How would that affect the equilibrium fare and amount of traffic? Explain your reasoning.
c. Would consumers agree that airlines should merge? Why or why not?
Source Michael Skapinker, "Crowded Skies," Financial Times, October 10, 2001.

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