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We Love To Fly Cheap, and We Hope It Doesn't Show
Subject Fixed and variable costs
Topic Production and costs
Key Words Money, economy, costs, fees, cost-cutting
News Story

The major airlines are losing money due to the weakening economy and rising costs. In reaction they are attempting to cut costs and increase fees. For instance, United and American are each trying to save $200 million.

The cost-cutting measures are designed to be transparent. United has terminated its practices of offering grapefruit juice and hot-towel service. In first class, linen tablecloths are no longer offered on short flights. A McDonald's kid's meal has been replaced by United's own version. Northwest will only offer first-class passengers one glass instead of two at dinner, arguing that passengers rarely drink both water and wine. The airline expects to save $150,000 a year. Another $100,000 will be saved by reducing oversupplies of miniature liquor bottles in international business class. Delta will wait to introduce new varieties of wine until all the stocks of the current varieties are finished. Southwest will print only 30,000 copies of its annual report, instead of 250,000, saving $200,000; stockholders will have to request a report if they want one.

American has introduced a $10 fee for paper, but not electronic, tickets, except where bought through travel agents. Full-fare and top frequent fliers are exempt. This is because paper tickets are more costly to issue. Overnight delivery of travel documents for trips starting more than seven days after booking will cost passengers $25.

(Updated June 1, 2001)

Questions
1.

a) What are variable costs?
b) What types of variable costs are airlines cutting?
c) Draw a diagram with axes representing prices and costs on the one hand and output on the other. Depict the average total cost and marginal cost curves. Show how reducing variable costs affects the cost curves.
d) Add a horizontal price line to your diagram. What happens to the profit-maximizing output level as a result of reducing variable costs?
e) Show what happens to the amount of profit.

2. a) What are fixed costs?
b) What types of fixed costs are airlines cutting?
c) On a new diagram showing the average total cost and marginal cost curves, illustrate the effect of decreasing fixed costs.
d) As in Question 1, add a price line and show what happens to the optimal output level when fixed costs fall.
e) Show what happens to the amount of profit.
3. a) Why are airlines concerned that consumers not notice the cost-cutting measures?
b) What might happen to the price line and amount of profit in your diagrams above if they do notice and they care?
Source Chris Woodyard, "Airlines rein in passenger frills to cut costs," USA Today, April 12, 2001.

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