South-Western EconNews

Yeah….Um…. I Want to Return $1.6 Billion in Planes?

Subject

Firm Reduces Costs as it Maximizes Profit in a Shifting Market

Topic

Supply and Demand; Product Markets; Production and Costs; Profit Maximization and the Firm

Key Words

Competition; Market Share; Demand; Costs

News Story

As consumers shift away from air delivery of goods to less-expensive ground delivery, UPS is negotiating with Airbus to cancel up to US $1.6 billion in A300-600 aircraft orders. UPS had ordered 90 Airbus A300 airplanes between 1998 and 2001, but is now trying to reduce that order by 20 aircraft. As of January of this year, UPS has already taken delivery of 32 planes, and others are in varying stages of production. Each plane costs approximately US $100 million to produce.

UPS has observed that demand for air delivery has been falling over the last few years, with demand for ground delivery picking up. While air transport is far more lucrative for UPS, the economic downturn in the last few years has caused companies and individuals to forego next-day air delivery in favor of the much cheaper ground transport. Further, competition with rival FedEx is getting more and more intense as each delivery company tries to gain market share over the other.

(Updated April, 2004)

Questions

1.	Use a graph of supply and demand to illustrate what is happening in the market for next-day air transport of cargo and letters.
2.	Even if UPS must pay a fee for each plane it cancels with Airbus, why would UPS have an incentive to do this? How does this decision maximize profits for the firm.
3.	Is this a long-run decision by UPS, or a short-run decision? Why? Explain your answer using an average total cost curves, making sure to to distinguish between fixed and variable costs.

Source

J. Lynn Lunsford, Daniel Michaels, and Rick Brooks. "UPS Seeks to Cut Order With Airbus As Market Shifts." The Wall Street Journal. 1 March 2004.