Worksheet

 Worksheet for Unit 11, Oligopoly:

Situation I:

Only two airlines fly non-stop between the two cities of Jamestown and Luke City.  (note we will assume for purposes of this exercise that non-stop is the only option for flyers.  Other options such as flights that connect in a third city, or that have 1 or 2 stops in other cities don’t exist in this example).  These two airlines are Air Astro and  Bigairways.  The costs of flying are pretty much all fixed costs since each airline flies one flight each day and it costs virtually the same to fly empty as it does to fly full.  There is enough demand to keep both airlines flying, however there are not enough customers to fill the flights of both airlines at the same time.  Typically there are only enough customers on any given day to fill each flight to 75% of capacity.  Since costs are mostly fixed, though, an airline that can obtain more customers than it’s competitor (larger market share) will be much, much more profitable.  The problem is that the only way to increase market share is by having a lower ticket price than the competitor.  If the two airlines offer different ticket prices, then the cheaper-fare airline will fill it’s airplane and make a large profit of $75,000 per flight per day.  If the two airlines offer different ticket prices, the high-fare airline will lose a lot of customers, have to fly it’s plane with fewer tickets sold, and earn a very, very small profit of only $1,000.  If the two firms both offer a low-fare, then they split the market 50-50 and they each make the same $20,000 profit.  On the other hand, if both firms were to offer the same high-fare, then they would again split the market 50-50, but now they would each make $50,000 in profit.

Directions:

Complete a Strategy-Payoff Matrix for this game, assuming that Strategy 1 is “low fare” and Strategy 2 is “high fare” and that Air Astro is firm A and Bigairways is firm B.  Be sure to identify all payoffs.  Then answer the questions. If the question asks for an answer that should be in dollars, just enter the whole number without any dollar sign, commas, or decimal.  For example, an answer of $37,000. should be entered as 37000

 

Strategy –  Payoff Matrix

Firm B
Strategy 1 for Firm
B:                    
Strategy 2 for Firm
B:                    
Firm A Strategy
1 for Firm A:
Payoffs for Possible OUTCOME A1-B1:
Firm A gets:
Firm B gets:
Payoffs for Possible OUTCOME A1-B2:
Firm A gets:
Firm B gets:
Strategy
2 for Firm A:
Payoffs for Possible OUTCOME A2-B1:
Firm A gets:
Firm B gets:
Payoffs for Possible OUTCOME A2-B2:
Firm A gets:
Firm B gets:

 

Situation I:

Only two airlines fly non-stop between the two cities of Jamestown and Luke City.  (note we will assume for purposes of this exercise that non-stop is the only option for flyers.  Other options such as flights that connect in a third city, or that have 1 or 2 stops in other cities don’t exist in this example).  These two airlines are Air Astro and  Bigairways.  The costs of flying are pretty much all fixed costs since each airline flies one flight each day and it costs virtually the same to fly empty as it does to fly full.  There is enough demand to keep both airlines flying, however there are not enough customers to fill the flights of both airlines at the same time.  Typically there are only enough customers on any given day to fill each flight to 75% of capacity.  Since costs are mostly fixed, though, an airline that can obtain more customers than it’s competitor (larger market share) will be much, much more profitable.  The problem is that the only way to increase market share is by having a lower ticket price than the competitor.  If the two airlines offer different ticket prices, then the cheaper-fare airline will fill it’s airplane and make a large profit of $75,000 per flight per day.  If the two airlines offer different ticket prices, the high-fare airline will lose a lot of customers, have to fly it’s plane with fewer tickets sold, and earn a very, very small profit of only $1,000.  If the two firms both offer a low-fare, then they split the market 50-50 and they each make the same $20,000 profit.  On the other hand, if both firms were to offer the same high-fare, then they would again split the market 50-50, but now they would each make $50,000 in profit.

Questions (you enter your answers in the Learning Management System for your school):

  1. If Air Astro chooses to charge a low-fare while Bigairways also charges a low-fare, the outcome is shown in which box of the Strategy-Payoff matrix?
  2. How much does Air Astro earn in profit if it chooses to charge a low-fare while Bigairways also charges a low-fare?
  3. If Air Astro chooses to charge a high-fare while Bigairways charges a low-fare, the outcome is shown in which box of the Strategy-Payoff matrix?
  4. How much does Air Astro earn in profit if it chooses to charge a high-fare while Bigairways charges a low-fare?
  5. If Air Astro chooses to charge a high-fare while Bigairways also charges a high-fare, the outcome is shown in which box of the Strategy-Payoff matrix?
  6. How much does Air Astro earn in profit if it chooses to charge a high-fare while Bigairways also charges a high-fare?
  7. If Air Astro assumes (or even knows for sure) that Bigairways intends to charge a high-fare, then what strategy would maximize profit for Air Astro?
  8. If Air Astro assumes (or even knows for sure) that Bigairways intends to charge a low-fare, then what strategy would maximize profit for Air Astro?
  9. Suppose that by some coincidence or accident, both Air Astro and Bigairways are both charging high fares. Now let’s assume Air Astro has assigned a new manager to this market and given her authority to change pricing strategy. Air Astro senior management has also told this new manager that if she can improve profitability she will quickly be promoted to a new assignment elsewhere and yet another new manager will take her place. What would our strategy-payoff matrix predict this new manager will do?
  10. Finally, let’s assume that this little “game” between Air Astro and Bigairways gets played once and that each airline gets to and that both airlines know the incentives, strategies, and payoffs of the other but don’t know which strategy will be chosen by the other. Let’s also assume that collaboration or collusion is not possible. Which outcome is most likely according to the Prisoner’s dilemma?