Scenario
In the island nation of Autarka, the government holds a monopoly over the provision of air freight services. Both the general public and business groups regularly complain about high prices and poor quality of service from the government-owned monopoly, Autarka Airfreight Services (AAS).
In response to these complaints, the national government commissioned the competition authority to recommend steps for improving the efficiency of the airfreight market. The commission made two recommendations:
- The airfreight services market should be opened up to competition from privately owned firms.
- Each rm operating in the airfreight market, including AAS, should be required to pay an annual lump-sum license fee to the government.
The competition authority expects that the reforms will lead to a lower cost, higher quality service. The national government of Autarka has pledged to implement all of the commission’s regulations.
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Industry structure
The airfreight market is best modeled as Cournot competition. This is because competing firms must hire aircraft and establish distribution networks before ordering airfreight services. Demand for airfreight services is,
P = 42 0:1Q;
where P represents the price of transporting a package, and Q is the total number of packages transported per year, measured in millions of packages.
At present, AAS charges $30 a package and transports 120,000,000 packages per year. While the firm is incident, it manages to return an operating pro t of $360,000,000 per year into government revenues.
The competition authority expects that after implementing the market reforms, all firms in the market (including AAS) will be more efficient. Each rm in the market will be able to transport a package at a marginal cost of $6 per package and face fixed costs of $100,000,000 per year.
Your task
The Minister for Transport has instructed you to recommend an appropriate license fee for the airfreight market. The minister has three objectives:
- Maximise government revenues from the license fee;
- Minimise the cost of airfreight services to consumers, and;
- Increase the number of packages transported per year to at least 250,000,000.
