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Oligopoly/game theory
1. Within Europe, the market for air travel is highly regulated. Entry of new airlines is severely restricted, and air fares are set by regulation. Partly as a result, European air fares are higher than US fares for routes of comparable distance. Suppose that for a given European air route (say, London to Rome), annual air travel demand is estimated to be Q = 1,500-3P (or, equivalently, P = 500-Q/3), where Q is the number of trips in thousands and P is the one-way fare in dollars. (For example, 600 thousands annual trips are taken when the fare is $300.) In addition, the long-run average (one-way) cost per passenger along this route is estimated to be $200.
a. Some economists have suggested there is an implicit cartel among European air carriers whereby the airlines charge monopoly fares under the shield of regulation. Given the preceding facts, find the profit maximizing fare and the annual number of passenger trips.
b. Suppose the European market were deregulated so that these routes became perfectly competitive. Find the competitive price and quantity of trips.
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