An island has one domestic airline and two foreign airlines flying to the mainland. The domestic firm has 55% of passengers and argues that airport charges ...
Question 1 Report
An island has one domestic airline and two foreign airlines flying to the mainland. The domestic firm has 55% of passengers and argues that airport charges are high. The government is considering a subsidy for domestic routes, but consumer groups want more foreign entry.
(a) Calculate the combined market share of the foreign airlines. [1]
(b) Explain one reason why airport charges can be a barrier to entry. [2]
(c) Analyse how additional foreign entry could affect the domestic airline's prices and profit. [3]
(d) Assess whether subsidising the domestic airline would benefit the island's economy. [3]
Answer Details
(a) The foreign airlines’ combined market share is:
\[100\%-55\%=45\%\]
Combined share = \(45\%\). [1]
(b) Airport charges increase the cost of operating flights. [1] A potential entrant may be unable to earn sufficient profit after paying these charges and may decide not to enter. [1]
(c) Additional foreign airlines increase supply and consumer choice. [1] The domestic airline may need to reduce prices or improve quality to retain passengers. [1] Lower prices and a loss of market share are likely to reduce its profit. [1]
(d) A subsidy could preserve domestic routes and jobs and maintain access for tourism or workers. [1] It may allow the airline to continue operating despite high costs. [1] However, it uses government funds and may protect an inefficient firm, weakening the pressure to reduce costs. Therefore a subsidy is most justified where the routes have important wider benefits, but it should not automatically be provided simply to protect the firm. [1]
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