Question

Section C (25 Marks) The government decided not to apply the tax, and a large airline company who can dominate the market starts to offer trips. Its supply curve (called marginal cost curve) for plane trips is different than the supply curve for the previous companies in the market: S2 = 350 + 50P (4) 1. What will be the new price of plane trips with the new supplier in the market? (5 Marks) 2. How many plane trips will now be provided by the airline companies operating before the large company entered the market? (5 Marks) 3. How many plane trips will now be provided by the new large airline company? (5 Marks) 4. How many plane trips will now be produced in total? (5 Marks) 5. Present the relevant diagram (5 Marks)

Answer 1

We assume the prices are in dollars ($)

Given the demand curve as:

D1 = 3000 – 200P1 + 30P2 + 2Y, where Y = $80000 and P2 = 500

So the demand curve can be re-written as:

D1 = 3000 – 200P1 + 30(500) + 2(80000)

D1 = 3000 – 200P1 + 15000 + 160000

D1 = 178000 – 200P1

1. When a large airline company who enters the market then the industry supply function of airline trips changes to:

S = S1 + S2

S = 300P1 + 350 + 50P1

S = 350P1 + 350     {New Industry Supply Curve}

Market clearing equilibrium is given as:

D1 = S

178000 – 200P1 = 350P1 + 350

178000 – 350 = 550P1

177650 = 550P1

P1 = $323

The new equilibrium price is less the earlier market clearing price (before the new entrant), that can be calculated as below:

Earlier supply curve: S1 = 300P1

178000 – 200P1 = 300P1

178000 = 500P1

178000/500 = P1

P1 = $356       {Old Market Price}

New price (323) < Old Price (356)

2. Number of plane trips that will be provided by the airline companies operating before the large company entered the market is given by:

Using the old supply curve: S1 = 300P1

S1 = 300(323)

S1 = 96900

3. Number of plane trips that will be provided by the new large airline company:

Using the supply curve of the new large airline company we get:

S2 = 350 + 50P1

S2 = 350 + 50(323)

S2 = 350 + 16150

S2 = 16500

4. Total number of plane trips that now will be produced:

S = S1 + S2

S = 96900 + 16500

S = 113400

Compared to the earlier market supply {S1 = 300P1 = 300*356 = 106800}, the new equilibrium quantity of plane trips supplied is higher at the new equilibrium price of $323.

5. The below diagram shows the market of plane trips: X-axis shows the quantity of plane trips demanded/supplied and the Y-axis shows the price of plane trip. Before the new large company enters the market equilibrium is given by the point E1 where the Market supply curve S1 and the market demand curve D1 intersects. Here equilibrium price is $356 at which 106800 units of plane trips are sold. As the new large company enters the industry, the industry supply increases shifts rightwards from S1 to S =S1 + S2. The new market equilibrium moves to E2, where the equilibrium price falls to $323 and the equilibrium quantity supplied increases to 113400 units.