Reference no: EM131278000

Scenario Description.

Bigjet plans to launch a weekly flight on a long-haul route. It faces four sets of decisions corresponding to short-run, medium-run, long-run, and very long-run operations.

Short Run. In the short run, Bigjet has temporary use of a smaller narrow-body air- craft. It has 60 square metres of floorspace for seating; the size is fixed. However, Bigjet may choose the configuration between business-class and economy seating. Each econ- omy seat requires 0.5 square metres, whereas a business seat is three times larger; it requires 1.5 square metres. Hence, Bigjet may operate a 120-seat all-economy aircraft, a 40 seat all-business aircraft, or any intermediate configuration. Furthermore, it must also set its prices for the two classes. Bigjet operates as a monopolist over this short-run period. Operation costs $60,000 for each weekly flight; there are no other costs.

Medium Run. In the medium run, Bigjet is free to choose any size of aircraft. An aircraft costs $1000 per square metre of seating space, per weekly flight. (This cost already accounts for the space lost to aisles, restrooms, and so on.) The space can be split between economy and business cabins. For example a large aircraft with 150 square metres of seating space would incur operating costs of $150,000 per weekly flight. If that aircraft were equally split between economy class and business class cabins, then the aircraft would contain 50 business seats and 150 economy seats.1

Long Run. In the long run, a competitor Fastair enters. Fastair faces the same costs as Bigjet. The two airlines simultaneously choose the size and configurations of their aircraft. (Note that Bigjet chooses a different strategy for the long-run competition with Fastair than it does for its medium-run operation as a monopolist.) They must predict the likely prices that they will receive for their tickets. However, for this long-run case, you can assume that the actual prices adjust to ensure that all seats on both aircraft are sold. Fastair is operated by Mike. His objective is to maximise Fastair's profit, he expects his competitor to think much like himself.

Very Long Run. In the very long run, Bigjet remains in competition with Fastair. However, available to Bigjet is an innovation which reduces the space required for an economy seat to 0.4 square metres, and reduces the space required for a business class seat to 1.4 square metres. If this innovation is adopted, then Bigjet and Fastair will once again have an opportunity to choose the sizes and configurations of their aircraft.

Demand Data.

The market size is 500 passengers per flight. Each potential buyer has a valuation for an economy seat, and a (higher) valuation for a business-class seat. Faced with a choice between two different classes of travel, a buyer picks the option that offers the largest gap between the buyer's valuation and the price.

A researcher has obtained a random sample of 100 valuation pairs. These are:

"Econ" and "Club" are the willingnesses to pay for economy and business class respectively. Hence you know perfectly the demand conditions in one-fifth of the market, and from this you must form an opinion about the properties of all 500 potential customers. You will work with this data for Q(1) and Q(2) below. After completion of those questions I will release feedback together with a full description of all 500 customers.

Prices and Purchasing Decisions.

An airline specifies the number of seats (economy and business) and their corresponding ticket prices. Once prices are set, the 500 potential passengers arrive one by one. Each passenger looks at the prices, and picks the best option, subject to seat availability. If all seats in the preferred class are sold then the passenger moves to his second choice.

Tasks.

(1). For the medium-run operation, specify the aircraft size and ticket price for (i) an all- economy aircraft and (ii) an all-business aircraft. Go on to specify (iii) the size, configuration, and ticket prices for a two-class aircraft. Predict your profit in each case.

(2). For the short-run, specify the configuration and ticket prices for an aircraft with the fixed overall size of 60 square metres. Predict your profit.

(3). For the long-run following Fastair's entry, specify the size and configuration of your aircraft. I will compute the prices that ensure both aircraft are full. However, please predict the prices and your profit. Explain how your decision would change if Fastair were restricted to offering only economy class.

(4). For operation in the very long run, provide a valuation of how much the innovation is worth to Bigjet (express this in terms of extra-profit- per-flight). Explain how this breaks down into (i) the direct cost saving, and (ii) any strategic effects.

Question 1: Medium-Run Monopoly Operation

(i) Economy class only:        Number of economy seats
                                            Price of economy ticket
                                            Predicted profit

(ii) Business class only:       Number of business-class seats
                                            Price of business-class ticket
                                            Predicted profit
(ii) Mixed-class aircraft:        Number of economy seats
                                            Price of economy ticket Number of business-class seats Price of
                                            business-class ticket Predicted profit

Question 2: Short-Run Monopoly with a 60 sq m Aircraft

Number of economy seats

Price of economy ticket

Number of business-class seats

Price of business-class ticket

Predicted profit

Question 3: Long-Run Duopoly Operation

(i) Fastair offers both classes:   Number of economy seats
                                                  Predicted economy price
                                                  Number of business-class seats
                                                  Predicted business-class price
                                                  Predicted profit

(ii) Fastair offers only economy:  Number of economy seats
                                                   Predicted economy price
                                                   Number of business-class seats
                                                   Predicted business-class price
                                                   Predicted profit

Question 4: Very Long-Run Valuation of a Product Innovation

Total valuation for the innovation

Direct cost saving

Strategic effect of the innovation

Attachment:- assignment.xlsx