Synopsis & Instructions
During the pandemic, airline ticket sales fell dramatically as demand for travel fell. In response,
some airlines starting charging historically low prices. For example, Frontier Airlines reduced its
round-trip tickets between New York City and Miami from over $200 to $51.
In this analysis, you'll apply concepts from class to consider the effects of demand changes on a
perfectly competitive firm's profit-max decision. Assume the following:
• Airlines operate in perfectly competitive markets.
.
The price the airline was charging was not high enough to cover its average total
costs of production (i.e., it was earning profit <0).
.
1. Was the decision to charge such low fares rational? Explain in words, why the airline
would be willing to accept such a low price in the short run.
2. Illustrate the airline's low pricing decision in a graph. Your graph should
include MR, MC, ATC, and AVC curves (all labeled)
labels for the profit-maximizing quantity as q, the profit-maximizing price as p*,
the ATC at q* as ATC, and the AVC at q* as AVC.
shaded-in and label the profit and/or loss the firm incurs.
.
The most substantial costs to airlines are fixed costs - salaries of flight crew,
contracted fuel costs, and lease space from airports. Variable costs are relatively
minimal. For example, variable costs might include additional meals served or
slightly more fuel for an additional passenger.
●
.
Remember, your graph should be "stand-alone" for the reader. Please note that you
don't need to use real numbers to create this graph.
3. In a few sentences, explain how you found q, p, ATC, AVC*, and profit.