BAA is a private company that operates some of the largest airports in the Unite
ID: 1207867 • Letter: B
Question
BAA is a private company that operates some of the largest airports in the United Kingdom, including Heathrow and Gatwick. Suppose that BAA recently commissioned your consulting team to prepare a report on traffic congestion at Heathrow. Your report indicates that Heathrow is more likely to experience significant congestion between July and September than any other time of the year. Based on your estimates, demand is Q_1^d = 600 - 0.25P, where Q_1^d is quantity demanded for runway time slots between July and September. Demand during the remaining nine months of the year is Q_2^d = 220 - 0.1P, where Q_2^d is quantity demanded for runway time slots. The additional cost BAA incurs each time one of the 80 different airlines utilizes the runway is pound 1,100 provided 80 or fewer airplanes use the runway on a given day. When more than 80 airplanes use Heathrow's runways, the additional cost incurred by BAA is pound billion (the cost of building an additional runway and terminal). BAA currently charges airlines a uniform fee of pound 1,712.50 each time the runway is utilized. As a consultant to BAA, what pricing plan would clearly enhance Heathrow's profitability? What price should BAA charge for runway slots between July and September? What price should BAA charge for runway slots for the remaining nine months?Explanation / Answer
Ans a) BBA experiences two kinds of market: one during conjection during July to September and the other during nine months from Setember October to June. Hence, it can discriminate the market during two time periods and treat them as two different markets. Therefore, it can use 'Third Price Discrimination' to optimise profits.
Ans b) BBA will charge a price for runway slots between July and September at which its Marginal Revenue from demand for runway slots between July and September is equal to its Marginal Costs.
Demand Curve: Q1 = 600 - 0.25P
=> Inverse Demand Curve: P = 2,400 - 4Q1
Total Revenue, TR = P * Q1 = (2,400 - 4Q1) * Q1
Marginal Revenue, MR = 2,400 - 4Q1 - 4Q1 = 2,400 - 8Q1
The cost of building an additional runway is a kind of fixed cost. Whereas 1,100 pounds are its variable cost.
Therefore, its marinal Cost, MC = 1,100
Now, MR = MC
=> 2,400 - 8Q1 = 1,100
=> 8Q1 = 1,300
=> Q1 = 162.5
=> P = 2,400 - (4 * 162.5)
=> P = 1,750 Pounds : Price charged during July to September
Ans c) BBA will charge a price for runway slots for other nine months at which its Marginal Revenue from demand for runway slots for other nine months is equal to its Marginal Costs.
Demand Curve: Q2 = 220 - 0.1P
=> Inverse Demand Curve: P = 2,200 - 10Q2
Total Revenue, TR = P * Q2 = (2,200 - 10Q2) * Q2
Marginal Revenue, MR = 2,200 - 10Q2 - 10Q2 = 2,200 - 20Q2
The cost of building an additional runway is a kind of fixed cost. Whereas 1,100 pounds are its variable cost.
Therefore, its marinal Cost, MC = 1,100
Now, MR = MC
=> 2,200 - 20Q2 = 1,100
=> 20Q2 = 1,100
=> Q2 = 55
=> P = 2,200 - (10 * 55)
=> P = 1,650 Pounds : Price charged during other nine months.
This also verifies that the price is higher when the demand is less elastic. Demand is less elastic during July to September in this case as with high conjection the demand is higher and does not respond to changes in prices.
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