South-Western College Publishing - Economics  
Have small plane, will travel.
Subject Smaller airplane creates a niche in the market and helps airlines on their costs.
Topic Oligopoly; Production and costs
Key Words

airplane, investment, costs, revenues

News Story

Airlines around the world have notices the advantages of smaller, more efficient jets to prop up slumping revenues and increasing costs. Enter the Embraer 170.

These new jets typically seat 72 people--in between the 50-seat commuter planes and the larger 150-seat jets--but with all the same comforts found in the larger planes. The two biggest airline manufacturers, Boeing and Airbus, have no plane in this category, but two smaller producers, Brazil's Embraer and Canada's Bombardier, Inc., have found what could be a very profitable niche for themselves. With a range of approximately 2000-2500 miles, these jets can easily reach the majority of domestic destinations in the US.

U.S. Airways is hoping that using these jets will help bring the company that emerges out of bankruptcy court a stronger company. It already has 20 of the planes, and plans on purchasing 65 more. Not only are theses innovative craft more efficient and cheaper to operate, but flight crews on smaller jets also tend to be paid less than do flight crews on larger planes.

Embraer noticed the gap in the airplane market in the mid-90s, and engaged in an $850 million investment in the "big small jet." Embraer hopes that demand for this size plane reaches 5,000 over the next 20 years. Given that neither Boeing nor Airbus has really seen a market response yet, it's not clear how high demand for these planes will go. It's clear to see, though, that as this size plane becomes more and more popular, Boeing and Airbus, the two airline giants, will either produce "big small jets" of their own, or they will begin discounting their smallest jets in competition with these new planes.

(Updated November, 2004)

Questions
1.

As US Airways buys these jets to help it out of bankruptcy protection, is the company engaging in a short-run or long-run production decision? Why?

2. Why would airline manufacturing be considered an oligopolistic industry? How could airlines be considered oligopsonists?
3. Assuming that airlines like US Airways are able to take advantage of cost savings from the new airplanes, what would you expect to happen to the cost of traveling? Why?
Source Jonathan Karp and Andy Pasztor. "High Hopes: To Cope with Travel Slump, Airlines Turn to Smaller Jets." The Wall Street Journal, 13 September 2004, http://www.wsj.com.

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