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In simple terms, economies of scale refer to an increased level of production leading to savings in cost. It is the process of all cost reductions that happen in response to increased demand for output This definition can also be graphically represented by moving along a certain downward sloping cost curve, operating in the long run. We can see that as the quantity produced is increased, unit costs, that is the cost per unit, are falling from C to C1.
Speaking more specifically to the example in the text; a large airline, such as the British Airways, is able to spread over its costs over the larger number of services provided (Caves, Christensen, & Tretheway, 1984). By using various strategies, an airline is able to achieve the benefit of economies of scale such as through international exposure and global expansion. This leads to a larger number of running flights that leads to lower costs with the increasing volume.
Large-scaled airlines are able to conduct frequent travel and are also able to offer a variety of destinations to choose from(White, 1978). This is why they are able to witness the benefit of economies of scale at large. This is because there is an increased number of passengers, the fixed cost of the carrier is distributed and the average cost per passenger carried falls.
Assuming, all other things constant, that the overhead cost of travelling from one destination to another over a distance of 100 miles is £5000. Now given that there are 5 persons travelling on the flight, would give out the per person cost to be at £1000. Now, let’s take the number of passengers increasing to 500, this would lead to the per passenger cost falling down to £50, hence reducing the costs for the airline at large(Caves et al., 1984).
Moreover, with the concept of globalisation, there is a demand for travelling that is now higher than ever. This serves as an opportunity for these large airlines(White, 1978), who have now adopted optimization strategies, to help reduce per unit costs. These range from online ticket processing to in-flight activities and assisted services.
However, one must also keep in mind that if the expansion is continued to a level where the cost of production per unit starts to rise, it leads to diseconomies of scale. In the airline industry, it can adhere to the fact that as an airline keeps on expanding and catering to more passengers, it becomes costly as well as difficult to monitor performance and labour. At this point there may be a need to hire a more professional workforce, an increased number of jets or the added fuel costs. Here the decreasing returns set in, as shown in the diagram above, with increased quantity the average cost starts to rise up again.
Competition policy can be described as the use of certain bodies or government policies in order to control the degree of competition in individual markets that exist within the economy(Motta, 2004). It sets a certain set of rules and standards to ensure that organisations and companies compete reasonably while encouraging efficiency and a healthy competition.
Even though evidently price competition seems to be in the favour of the consumer, its aim at large works in the interest of the overall economy(Aghion, Dewatripont, & Rey, 1997). The competitiveness within the EU single market contributes to its growth through various factors.
Firstly, it ensures a low-cost initiative as the main element of gaining share in the market would be by providing competitive pricing. In addition to the fact that is beneficial for the consumer, it helps businesses produce more and adds to the development of the economy(Besley, Persson, & Sturm, 2010).
Secondly, competition also encourages businesses to improve the quality of goods and services they sell to attract more customers. Likewise, in the effort to make their products stand-out and achieve an edge over the rivals, businesses will attempt innovation (Teece, 1992)and technological efficiency, resulting in an extensive range of choice for the buying consumer. This also gives producers a standing in the global market.
The European Union adopts a strict competition policy(Cini & McGowan, 1998b). The most important initiative is the abolishment of a cartel system. This ensures that there are no unfair negotiations or agreements within businesses, that may allow them to exploit the consumers by taking advantage of their collusion. The EU also provides subsidies and benefits(Cini & McGowan, 1998a) to encourage the growth of small companies and new entrances in the economy, in order to keep the competition flowing(Motta, 2004). More importantly, there are strict checks and regular investigation processes during any sort of takeovers or mergers, in order to ensure accordance and the abolishment of oligopoly between large firms.
(Source: European Commission Press Release)
In February 2011, there was an investigation initiated by the European Union in two of very well-known airlines, namely Deutsche Lufthansa and Turkish Airlines(“EU launches Lufthansa code-share probe,” 2011). The German and Turkish airlines, respectively, were suspected of collusion that breached the EU’s policy. The issue at hand was that the commission believed that a certain code-sharing between the two airlines was subject to be harmful to the consumer’s interest and seemingly served as an anti-competitive strategy. The commission suspected that the agreement at hand was made in order to eliminate competition and form an illegal collusion. The altered pricing, overall capacity reduction, as well as granting the right to sell unlimited seats on each other’s flights on a major competing route, were a few of the main concerns presented.
However, upon further enquiry, the investigation was concluded(“Press release,” n.d.) in 2016 upon the absence of a direct violation of the EU competition rules. This was largely based on the facts that the airlines had adopted different pricing strategies and did not have complete access to each other’s seating arrangement. Also, most importantly, since Deutsche Lufthansa and Turkish Airlines were not the only airlines operating on the aforementioned route, the share of their sales acquired through this code sharing was rather minimal.
The price elasticity of demand is used to show the responsiveness of the quantity demanded of a good or service to a change in its price, keeping all other factors constant. In this particular question, we are trying to see how the demand for this airline changes given that nothing else, but the price is altered(Jung & Fujii, 1976). Due to the inverse relationship, there is the presence of the negative sign, however, a value less than one determines the inelasticity of nature and vice versa.
The PED figures for the different types of flights tells us about the variations in revenue with the Cutting Price Strategy executed by Low-Cost Airlines(Borenstein & Rose, 1994). These figures depict that flights taken by passengers for business reasons are relatively inelastic and so the strategy will actually lower the revenue of the carriers. This is because trips made for a business cause are work-related and, hence, rather important despite the price change. However, for passengers taking flights for leisure purposes, revenue does increase slightly in the case for the long haul and considerably in the case of short-haul flights(Jung & Fujii, 1976). Overall, the airline’s strategies’ success depends on the ratio of Business to Leisure passengers. If leisure passengers considerably outweigh the business and more so in the short haul, then the carrier’s cutting price strategy to boost passengers and revenue will be successful. It will, however, be unfruitful should business passengers be in the same amount to leisure or even slightly lesser.
- A) Given a floating exchange rate system, the depreciation of currency refers to the loss of value of a country’s local currency with respect to a foreign currency.
Coming as no surprise, the British currency, commonly known as Sterling, depreciated more than ten percent right after the result of the European Union referendum held in 2016 as the UK decided to leave(Allen, Treanor, & Goodley, 2016). Even though it had been one of the strongest performing currencies of all time, the Sterling dropped at an all-time low, exchanging at $1.335 against the US dollar.
The choice of the United Kingdom to leave the European Union after being an integral part for 43 years, an event commonly referred to as Brexit, shook the exchange rate and stock markets all around the world. The pound drastically fell(Plakandaras, Gupta, & Wohar, 2016) by almost fifteen percent in less than a week, with respect to the dollar, after the decision was announced. Using economic evaluation to figure out the reasoning of this fall, we discuss below.
Firstly, the issue of uncertainty arises. Exiting the EU would create a sense of vulnerability among investors, that would, in turn, debilitate both portfolio streams as well as inward investment. Therefore, there would be less interest in purchasing Pound Sterling to invest resources in the UK. Moreover, The UK has a substantial current account(Allen et al., 2016) deficiency, which is financed by net capital inflows. As discusses previously, in the event that these inward flows are reduced, the Pound will have to fall in order to balance the current account.
Another major issue was the loss of access to Single Market(Fligstein & Mara-Drita, 1996), that allowed foreign organizations to conduct trade UK to Europe without duties and non-tariff barriers by leaving the single market, many companies may continue to trade within countries that are part of the EU rather than the UK itself. This could prompt a relative decrease in the UK’s inward investment and hence decrease the value of Sterling.
However, it must be kept in mind that the depreciation of the pound(“Why would Pound Sterling fall after Brexit?,” n.d.) will cause UK exports more competitive and hence their quantity should increase. A depreciation in the exchange rate would help the local exporters and boost their growth prospects, however, may cause inflation(“UK inflation rate leaps to 2.3%,” 2017).
As imported goods become expensive, the prices would rise, likely to cause a cost-push inflation. On the other hand, as the value of pound falls, there will be a larger demand for the goods and services offered by the UK and the locally produced goods will be attractive to the foreign market. This will again cause a rise in demand that commonly leads to demand-pull inflation This is determined by the diagram as the supply of pound increases and is more easily available due to a reduction in local price.
- B) A simple example would be assuming that a £1 used to equal $2 but due to the anticipated…..