Economics: Risk Management, Moral Hazard, and Organizational Structure

This economics report evaluates various aspects of risk and uncertainty in the context of Southwest Airlines. It examines the company's actions in dealing with risk, suggests improvements to risk management strategies, identifies and analyzes a principal-agent problem within the company, and explores adverse selection issues. Furthermore, the report determines how the company manages moral hazard problems and proposes best practices for addressing them. Finally, it examines the organizational structure of the company and suggests changes to improve overall profitability. This report provides a comprehensive overview of key economic concepts applied to a real-world business scenario.

0Running head: ECONOMICS
Economics
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TABLE OF CONTENTS
QUESTION 1.............................................................................................................................2
QUESTION 2.............................................................................................................................3
QUESTION 3.............................................................................................................................4
QUESTION 4.............................................................................................................................4
QUESTION 5.............................................................................................................................5
QUESTION 6.............................................................................................................................6
Reference list..............................................................................................................................7

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Introduction
Southwest Airlines is one of the famous airlines in the United States of America and
is also known to be one of the world’s low-cost carrier (Fu et al., 2019). This airline is known
to carry the most domestic passengers of any United States airline.
QUESTION 1
Evaluate a company’s recent actions dealing with risk and uncertainty
There are always a presence of high risk and uncertainties involved in the business of
airlines. The difference between risk and uncertainty is that uncertainty is an unknown risk
whereas risk is he measurable uncertainty (Zenger & Gubler, 2016). The risk involves the
possibility of losing some of the original investment. It is the likelihood that an investment
will be affected by various conditions of macroeconomy such as regulation of government,
political stability and exchange rates. On the other hand, uncertainty is the occurrence of the
unpredictable outcomes.
 Responding as quickly as possible: one of the best possible way of dealing with risks
in the airline uncertainty is ensuring that they respond within the shortest period of
time.
 Another risk that is faced by the South West Airlines is that they have to run their
flight even when the seats are not full. In such situations, the airlines have the risk of
earning low revenue. The Southwest is known to deal with the risk by pursuing a low
cost strategy or no frills strategy where passengers of the single class of service are
offered the lowest possible fares which makes air travel affordable to a huge number
of people of the United States.

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 They have also known to use various kinds of analytical techniques which do not
require high level of accuracy. It helps the airline company in identifying various risks
and uncertainties.
 They have also known to maintain their reputation in the industry. The success of the
airline industry is mostly attributed to the productive and motivated workforces in the
world.
 Another risk is that the South West Airlines are at constant price wars with its
competitors where one of the airlines have to cut fares on certain routes which will
force the other airline to reduce their fares. In this case the South West Airlines have
eliminated the risk by developing one of the simplest and straightforward fare
structure of any major airline where the customers
QUESTION 2
What are the advice for improving risk management ?
For any kind of industry, the best way to deal with the risk and uncertainties is to
identify and resolve them. The organizations should be working faster in adopting and
integrating modern technology into the system. The South West Airlines are known to make
use of financial instruments for hedging the fuel risks. On the other hand, one of the airlines
have known to purchase an oil refinery. Below mentioned are some of the ways by which the
risk and uncertainties are dealt. One of the strategy is financial hedging strategy where it will
be making the value of the firm less sensitive to change in the risk factor. Another strategy
that is used for improving the risk management is the benchmark strategy. The firm which
follows the benchmark strategy are known to be doing sensitivity test. The essence of the
financial hedging is that it will be making the value of the firm less sensitive to changes in the
risk factor. When the risk factors around the expected value, the profits are known to be
under the financial strategy. The South West Airlines are also known to use the OpSuite

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QUESTION 3
Identify a principal-agent problem in your company and evaluate the tools it uses to
align incentives and improve profitability.
The principal agent problem known to take place when the principal creates an
environment where the incentive of the agent does not align with the principle. The principle
agent problem is known to make decisions and take actions on behalf of the other entity.
There is absence of unique solution to the principal agent problem of the firm. The principle
agent problem is also an example of market failure. The agent is to have more information
than the principle.
QUESTION 4
Examine an adverse selection problem your company is facing and recommend how it
should minimize its negative impact on transactions.
Adverse selection is a kind of situation where the producers will be having
information which is not present with the buyer. Like for example in case of insurance, the
adverse selection is the tendency of those in high risk lifestyle is known to purchase the life
insurance. In case of the adverse selection it can be said that, there will be presence of
information asymmetry when one party to a transaction is known to have better information
than the other party. The adverse selection can be termed as a situation where sellers will be
having information that the buyers do not have. The airlines should be ensuring that they
should not be losing money (Wagner, Mylovanov & Tröger, 2015). However, it becomes
tougher for the airlines industry to make profit every time. In case of South West Airline,
they seem to charge a high amount for a round trip. However, the passengers are not aware of

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the expenses they are actually paying. some of the travellers will also not inform the actual
scenario of the airlines and this kind of adverse selection was further hyped since the airline
attempts for delivering through marketing along with advertising.
It is therefore advisable to increase the quality of the deliverables and cope with the
changes. South West Australia should also provide better estimates by spending the
minimum time and should be spending more on the quality of the services.
QUESTION 5
Determine the ways your company is dealing with the moral hazard problem and
suggest best practices used in the industry to deal with it.
Moral hazard is the risk where a party have provided misleading information and did
not enter in to the contract in good faith. The airline industry is known to rely purely upon the
customers and therefore they work best for attracting majority of the consumers who are
willing to travel by air. The moral hazard is therefore a risk where the party to a transaction
did not enter the contract having in good faith. It has also known to provide misleading
information about certain issues like liabilities. The airline company South West have
promised its customers about the new flights to new destinations (Hébert, 2017). However, it
has failed to provide them in timely manner. In this kind of situation, it will be leading to
decline in the market share and for this only few customers will be choosing their airlines. In
this way when the company is losing consumers it will also be laying off its employees. The
Southwest airlines should therefore, work on its quality of the services, should also deliver
the promised services to its consumers. By offering bonuses to its employees for completing
the tasks or by even by providing incentives, the airlines can avoid moral hazard problem.

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QUESTION 6
Examine the organizational structure of your company and suggests ways it can be
changed to improve the overall profitability.
The organizational structure is a system which is known to outline how certain
activities are known to be directed for achieving the goals of the organization. The activities
basically comprise of the rules, roles along with the responsibilities. The organizational
structure is also known to determine how the information flow from level to level within the
company. There is presence of three layers of the management. The senior vice president, the
CEO and the COO is known to handle the planning as well as the strategy. The directors
along with the vice president are known to handle the analytical process. The team leaders
and the managers are known to assign the work and control the performance. However, poor
structure can lead to poor communication between departments. For this reason customers
might also become frustrated by the lack of cooperation. Therefore, it should be improving
the communication present between the various departments so that the quality of the work is
also improved.

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Reference list
Fu, X., Jin, J., Liu, S., Oum, T. H., & Yan, J. (2019). Exploring Network Effects of Point-to-
Point Networks: An Investigation of the Spatial Patterns of Southwest Airlines’
Network. Transport Policy.
Alamdari, F., & Fagan, S. (2017). Impact of the Adherence to the Original Low-cost Model
on the Profitability of Low-cost Airlines. In Low Cost Carriers (pp. 73-88). Routledge.
Daft, R. L. (2015). Organization theory and design. Cengage learning.
Cvitanić, J., Possamaï, D., & Touzi, N. (2016). Moral hazard in dynamic risk
management. Management Science, 63(10), 3328-3346.
Wagner, C., Mylovanov, T., & Tröger, T. (2015). Informed-principal problem with moral
hazard, risk neutrality, and no limited liability. Journal of Economic Theory, 159, 280-289.
Kirkegaard, R. (2017). A unifying approach to incentive compatibility in moral hazard
problems. Theoretical Economics, 12(1), 25-51.
Zenger, T., & Gubler, T. (2016). Agency Problems. The Palgrave Encyclopedia of Strategic
Management, 1-4.
Hébert, B. (2017). Moral hazard and the optimality of debt. The Review of Economic
Studies, 85(4), 2214-2252.