The Cost of Competition

Topics: Economics, Marketing, Game theory, Microeconomics, Supply and demand, Monopoly / Pages: 7 (1514 words) / Published: Jan 15th, 2013
Executive Summary

To identify an appropriate strategy for a given industry one must look into the external and internal factors influencing the company. This Schnell Air report has been conceived with a triple objective in mind: to provide the Schnell Air Board with (i) a brief and compelling synthesis of Schnell Air’s competitive market environment overview since it entered the Innsbruck – Turin route in January 1997 as compared to prior to its entry, (ii) analyse the available data to establish the extent of predatory pricing strategies being plotted by the two existing duopolies – Air Turin and Innsbruck Air and (iii) by using a Game Theoretic approach model and highlight the affect of a 4th daily service on the same route given the declared intentions by the incumbent Airlines. The market structure and the subsequent change of the three airlines before (Jan’97) and after (Jan’97-Sep’ 97) entry is provided below.

Market Situation Prior to January 1997

The market environment before January 1997 was a duopoly between two large carriers Air Turin & Innsbruck Air. Based on the assumption that both airlines exhibited rational behaviour, it was in their advantage to collude and set the price and their individual outputs at levels that would maximize their joint profits. This situation (illustrated in Appendix, 1.1), shows the demand curve, given by DD, as the individual firm 's share of the market demand under circumstances where the two firms are identical with respect to size and costs of production. To understand this behaviour of the collusive duopolies, a mathematical tool called ‘Game Theory’ is used. The classic example for the duopoly analysis here is the ‘Prisoner 's-dilemma game’ (shown in Appendix, 1.2). Within this game structure, a payoff matrix has been plotted, which shows the outcomes (each carrier’s profits) for all four combinations of collusion. By understanding the various ‘payoffs’ (referring to the profits or losses that will result from

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