United Airlines is considering expanding its service from Greensboro’s Piedmont Triad International Airport (GSO). They are considering two options and you are asked to evaluate the profitability of the different choices over several subparts of this question.
There are currently no other airlines providing direct service to Boston Logan airport. Given the number of local students who live in the northeast, United has estimated the inverse-demand for this flight to be P = 500 Q, where Q is the number of seats sold per day, and that the total cost per day is 100Q. First, what market structure best describes this flight from GSO to BOS? Next, find the profit maximizing Quantity, Price and Profit from operating this flight.
Another option for United is to add service to Miami, as many local students enjoy visiting the area, especially in mid-March. There is currently one direct flight offered per day to Miami, by American Airlines. The estimated inverse demand for seats to Miami is
P = 990 2Q, where Q is the total quantity sold per day. (Hint: If both American and United offer seats the inverse demand curve is P = 990 2(QA + QU), where QA is American’s quantity and QU is United’s quantity). American has a total cost of 100QA for seats to Miami. United has found a way to have a total cost of 50QU.
Show that the reaction functions for the airlines are
QA =222.5 0.5QU and QU =235 0.5QA
If the two airlines announce their flight schedule at the same time (Cournot competition), how many seats will each airline offer per day (QA and QU), what will be the market price and how much profit will each airline make?
As the incumbent airline, American can announce their flight schedule before United does (Stackelberg competition). If American announces first and United also offers service to Miami, how many seats will each airline offer (QA and QU), what will be the market price and how much profit will each airline make?
What advice would you give to United Airlines based on you analysis? Which market, if any, would you recommend they enter and why? You should keep in mind that American Airlines is a competitive firm and also wants to maximize profit.