Managerial Economics-Airline Case

Running Head: MANAGERIAL ECONOMICS-AIRLINE CASE
Managerial Economics-Airline Case
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1MANAGERIAL ECONOMICS-AIRLINE CASE
Table of Contents
Answer 1..........................................................................................................................................2
Empirical study to investigate economies of scale in airline industry.........................................2
Answer 2..........................................................................................................................................3
Mergers in the airline industry.....................................................................................................3
Answer 3..........................................................................................................................................5
Disadvantages of hub and spoke system.....................................................................................5
Answer 4..........................................................................................................................................8
Hub and Spoke networking system and Economies of scope.....................................................8
Answer 5..........................................................................................................................................9
Economies of scale......................................................................................................................9
Economies of Scope..................................................................................................................11
Answer 6........................................................................................................................................12
Economies of scope in the airline industry................................................................................12
Answer 7........................................................................................................................................13
Overcrowding in Airlines and diseconomies of scale...............................................................13
Reference list.................................................................................................................................15

2MANAGERIAL ECONOMICS-AIRLINE CASE
Answer 1
Empirical study to investigate economies of scale in airline industry
Economies of scale arises when increasing size scale of production is associated with a
declining unit cost of production. It implies a falling average cost in the long-run. In the airline
industry if economies of scale exist, implying the average cost of airline decreases with increase
in the output level then the concentration in the industry is justified based on cost savings. The
economies of scale can be measured with respect to size of the firms. In order to examine the
presence of economies of scale in the airline industry empirical data needs to be collected on
overhead cost of the concerned airline. The airlines incur both fixed and variable costs. The fixed
cost of airlines includes cost of financing aircrafts, insurance fees, Tax and registration fees,
aircraft accessories, salaries of the crewmember (Carlton & Perloff, 2015). The variable costs are
costs that varies with the level of output. For aviation industry, the variable costs are cost of oil,
fuel, fees of landing, catering, and salaries to crew paid on hourly basis, maintenance cost and
others. The information regarding scale of economies implies data should be gathered on costs.
The economies of scale in the airline industry arise when the company uses a single type of
plane.
In the airline industry, the fixed costs are generally higher than the variable cost.
Therefore, with increasing number of passengers the overhead cost reduces leading to economies
of scale. The knowledge regarding the overhead cost is required to conduct empirical study on
airlines. With increasing operation, the unit cost should be reduced. As the aviation industry
provides services, the output or firm size cannot be measured like that of physical good (Ostrom,
2016). The operational efficiency are measured in terms of number aircraft that the company
built.

3MANAGERIAL ECONOMICS-AIRLINE CASE
Another source of economies of scale in the airline industry volume discount benefit. The
big airlines often gets a better deal for dealing with range of supplier for the bulk purchase
(Ambulkar, Blackhurst & Grawe, 2015). The decision regarding presence of economies of scale
focus on analysis of operating cost. For this, appropriate form of cost function should be used.
For example, in the absence of any economies of scale a cost function in linear form is
appropriate. With presence of economies of scale form of arithmetic cost function is appropriate .
The size of the airline may be measured in terms of seat-miles, ton-miles, and revenue-
passengers’ miles and so on. The cost characteristics are cost of ground handling (Li, Wang &
Cui, 2016). The economies of scale depend on the fact that whether marginal cost of this activity
goes down with increases the volume of airlines at a particular airport.
Answer 2
Mergers in the airline industry
Merger refers to the corporate strategy of joining different business organization together
to become a single company. This enhances both the financial and operational strength of the
merged companies (Prince & Simon, 2017). For the airline industry the strategy of merging is
not a new idea. There are generally three primary motives of mergers.
Monopoly motive: When two or more companies merged to form a single company then a
strong company is formed. This enjoys a greater market power resulting from the reduced
competition. The single firm may behave like a monopolist in the market.
Speculative motive: The merging of two or more companies raise the speculative power of the
companies.