AJC H2 Econ Case Study

ANDERSON JUNIOR COLLEGE JC2 Preliminary Examination Hi gher 2 READ THESE INSTRUCTIONS FIRST Write your name, PDG and index number in the spaces provided on all the work you hand in. Write in dark blue or black ink. You may use a soft pencil for any diagrams, graphs or rough working. Do not use staples, paper clips, highlighters, glue or correction fluid. Answer all questions. Begin your answer to each question on a fresh sheet of writing paper. At the end of the examination, fasten your answers to each question separately. Fasten this cover page in front of your answers to Question 1. The number of marks is given in brackets [ ] at the end of each question or part question. Name: ________________________________ ( ) Question Number Marks Awarded 1 PDG: _________________________________ 2 Total Marks /60 ECONOMICS 9732/01 Paper 1 10 September 2008 2 hours 15 minutes Additional Materials : Answer Paper This document consists of 7 printed pages, including this cover page. [Turn over

2 Answer all questions Question 1 Deregulation of Airline Industry Extract 1: Freedom in the air Europe deregulated air travel in 1997 almost twenty years after America in 1978. In the past, the industry was dominated by national ‘flag’ carriers or ‘network carriers’, such as British Airways, Air France and KLM (Netherlands). Flag carriers have often been regarded by their home government as being an important and highly visible symbol or totem of the country itself. As such, many governments have protected their national flag carri er from competition. Such measures might include direct government subsidy, government-dicta ted airfares and route networks, prevention of buying take-off and landing slots at major airports or simple price fixing. Since deregulation, airlines have been largely free to negotiate their own operating arrangements with different airports, enter and exit routes easily, and to levy airfares and supply flights according to market demand. Any technically qualified airline in the European Union (plus Norway and Iceland) will be able to run services inside any other country without any need for government approval. Competition between European airlines has increased. At present an all-out war rages not just between low-cost carriers but with network carriers as well. Network carriers such as British Airways have successfully adopted the internet-selling and yield-management techniques of low-cost rivals. They are not always as cheap as the likes of low cost carriers such as EasyJet and Ryanair, but often at busy periods, their fares to holiday resorts compare well. The traditional airlines also offer business travelers a wider range of flights to helpful destinations at prices from London Heathrow airport that are competitive with low-cost carriers flying fr om London's more distant, secondary airports like Stansted and Luton. Extract 2 : Low-fare, no-frills airlines are shaking up Europe’s national flag carriers The rise of the two major budget airlines Easyjet and Ryanair, has been little short of stratospheric. The deregulation of the European airline industry gave Michael O’Leary and Stelios Haji-Ioannou, the charismatic heads of Ryanair and Easyjet respec tively, the opportunity to seize market share from the flag carriers. A number of factors had coincided to assist them. Real annual GDP growth in the UK and Irish economies was above trend at 3% and 7% respectively. Narrow-body Boeings and Airbuses, the sort favoured by budget airlines, are available at roughly half what they cost in the late 1990s. Off-the-shelf software that runs the internet-based bookings systems crucial to a low-cost carrier, handles the demand-management system that jacks up prices as a flight fills up. A budget carrier will typically multiply some fares tenfold in the run-up to a holiday such as Easter. Perhaps the most basic push behind the flock of new little airlines is the availability of a simple and proven business model—developed in America by Southwest Airlines and copied first in Europe by Ryanair and EasyJet. The essential elements of t he business model were: a single-type fleet of planes; fast turn-rounds (i.e. almost immediate take-off after landing); use of cheaper secondary airports; no provision of frills such as in-flight meals, free drinks and assigned seats. These cost- saving measures mean that budget airlines typically require 25% fewer staff per flight than the traditional flag carriers. It is no surprise that loads of other budget airlines such as Air Scotland, bmiBaby have sprung up, keen to imitate the success of Easyjet and Ryanair. Aviation Economics, a London-based travel consultancy, estimates that it can cost as little as $10m to start up an airline. Aircraft can usually be hired, software is cheap and staff can be employed on short-term contracts. Adapted from Economics Today, November 2005

Figure 1: Evolution of Low Cost Airlines’ Market Share in the EuroControl Statistical Reference Area (ESRA) 1 Current market share of low cost carriers Change in market share in the last 6 months Source: EuroControl, 2004 Extract 3: Clean green flying machine Airports want to grow because more people want to fly. Last year passengers took some two billion trips on scheduled airlines. In 2010 that number is forecast to have risen by a quarter. Much of the recent growth is attributable to short-haul low-cost airline travel. But cheap flying has come with costs attached. By most measures aviation gener ates 2-3% of man-made emissions of carbon- dioxide, the main greenhouse gas. The contribution to global warming could be more severe. Jet engines also pump out nitrogen oxides, soot and water vapour at high altitude. Scientists disagree about the added consequences but a recent report commissioned by the British government suggests that this might double the warming effects of carbon-dioxide emissions from planes. Most environmentalists think that the only solution is to stop people flying. Making air travel more expensive, say through hefty fuel taxes, would put off price-sensitive leisure flyers. Airlines are accused of having a free ride in terms of air pollution because they pay no tax on the fuel used for international flights. But airlines say that protesters have it in for them because they are an easy target. In fact, they say, the airline industry produces far more benefits than ills. Some studies suggest that aviation contributes as much as 8% to global GDP by transporting tourists, business travellers and cargo around the globe. Governments and international bodies are intent on encouraging the industry to make greater efforts. A global emissions-trading scheme, drawn up under UN auspices, is set for consideration 1 ESRA includes western Europe plus Greece, Turkey, Malta, Cyprus, Hungary, Norway, Denmark, Czech Republic, Slovenia, Slovakia, Sweden, Italy, Romania, Croatia, Bulgaria, FYROM, Moldova, Finland 3

4 later this year. The European Commission plans to introduce trading in 2011 for all carriers based in the European Union. Later the scheme might, possibly, extend to all airlines operating there. The introduction of carbon-trading is a welcome step by governments that are not yet willing to consider a carbon tax. The air-travel industry should have to stump up for the pollution it causes. And anyone priced out of a cheap holiday in Spain might like to consider a week-long camping break near Heathrow. Adapted from The Economist, Aug 14th 2007 Questions a (i) Distinguish between fixed and variable costs. (ii)