micro economics project

1. Commentary: Kirthank: Boeing Airbus price war duopoly
Graphs - Kinked Demand Curve, Economies of Scale
Airbus and Boeing are duopolistic firms that produce airplanes. Airbus and
Boeing are currently in a price war, in order to gain market share past that of the
traditional 50-50/45-55 market share. Airbus is currently the number one airplane
firm, with exceptional sales on their A320neo plane. Both Boeing and Airbus enjoy
similar market share, and the consumers’ preference is generally 50-50%.
Whether Boeing or Airbus started the price war is not clear, but their
situation can be shown in a kinked demand curve
:One firm lowers price, other reacts by making it cheaper (oligopolistic kinked
demand curve):
This does not benefit consumers as plane ticket prices will be significantly increased,
as both companies will have to make up for the lost revenue in the price war. Both
Airbus and Boeing do not benefit from this current decision in the short run, as they
are lowering their average revenue, which could harm the company badly. However,
in the long run, if one firm is able to drive the other down to a loss (as the average
revenue will be lower than average cost of building a plane leading to less output),
then that firm will be able to gain significant market share, and potentially gain
monopolistic market power. This can be applied to the game theory. Neither firm will
collude (as it would become a monopoly, which would restrict the market). If one firm
cuts the price, the other firm can either decide to lower their price and AR to increase
sales by a small amount, or keep price the same, leading to loss of consumers.
Moreover, by earning market share past the normal 45/55, then that firm
will be in an economies of scale, coming away with high efficiency and beneficial
experience.
:Economies of Scale Graph:
By surviving a price war, either Boeing or Airbus will have maximized efficiency.

2. Because AR is decreasing during the price war, both firm will have to cut labor and
variable costs. They will cut workers they find not performing to maximum efficiency.
By the time the price war is over, the remaining firms will have cut down their
average variable cost down to only that which is necessary, and have a smaller yet
more efficient labor force. This allows them to survive better for future price wars,
thus making it a long run benefit. This experience allows them to allocate their labor
force more efficiently, and in preparation for future competition. In the short run, by
minimizing variable cost, it also minimizes average cost and operating loss the firm
faces during the price war.
As Boeing and Airbus are now in a price war, they cannot stop now. This
means that this is the only future action they can take that can be predicted as of
now. If they continue, I would suggest to cut down on variable costs, as while it may
not benefit workers, it will allow one or both firms to gain more maximum efficiency at
the lowest cost. This would not benefit consumers, as the AR of both firms will
decrease with the price war, leading to higher priced plane tickets to make up for the
loss. It will not benefit the government as they get less room to intervene, as taxation
is limited. Overall, this action will benefit both firms in the long run, as one or both will
gain efficiency, more experience to overcome future competition, and lower variable
costs at the end of the price war. It also allows them to operate at the maximum
efficiency at the lowest variable cost possible. In the short run, however, it reduces
AR, meaning that both companies have the potential to operate at a loss, and more
consumers will have to pay the burden that both firms face.
Duopoly market
is a market condition in which only two firms have dominant controlover a market,
they own all or nearly all of the market for a given product or service. Aclosely related
concept is a monopoly, a situation in which a single company dominates
themarket. A duopoly is the most basic form of oligopoly (a market dominated by a
smallnumber of companies). Boeing and Airbus have been called a duopoly for their

3. command ofthe large passenger airplane market; in just the same way as Cola and
Pepsi dominates thefizzy drinks markets.This case study shows a perfect example
of duopoly market detailing the intensity of thecompetitionbetween the two dominant
companies in the Civil aviation and aircraftmanufacturing industry (Boeing
and Airbus). The paper also presents facts, figures andcomparisons of sales and
orders for both companies for the period between 1996 and 2006
(Exhibit I and II).
After Lockheed Martin pulled out of the airplane production business inthe early
1980s and McDonnell Douglas (a major American aerospace manufacturer
anddefence contractor) merged with Boeing in 1997, only Boeing and Airbus were
left tomanufacture the largest commercial airplanes
Only Two firms in the industry
The industry of airplane manufacturing is highly capital-intensive due to the great
demandfor expensive technology and the need for highly skilled expertise. Success
and survival ofaviation companies is also linked to available support and subsidies
from respectivegovernments, which gives clues as why the Civil aviation and aircraft
manufacturingindustry is mainly concentrated in the affluent United states and
Europe? And why thereare few new non-major market entrants.
The 787 Dreamliner, developed by Boeing, is a long-range,
midsized, wide-body,twin-engine passenger airliner. As in terms of capacity, it is
meant to be a complement to777 rather than a competitor The A350 XWB (extra
wide body) is Airbus’ response toBoeing’s Dreamliner, it competes with the high end
of the 787 and the low end of the 777 markets. The design for the new Airbus 350 is
an improved version of the A330, started inresponse to Boeing presentation the
Dreamliner 787
. In 2006 Airbusbegan to consider a wider body, a larger wing, more powerful
engines, a higher cruise speedand many other changes to satisfy the airlines. So,
Airbus presented the A350 XWB withentirely new design. The new A350 looks

4. radically different from any previous twin-aisleAirbus. The new wider Airbus A350
XWB body will enable the plane to accommodate slightlywider economy seats than
its rival. The new design maximizes usable volume by having aconstant
cross-section from door one to door four.
Adaptability to change:
The goal of 787 Dreamliner’s design team was to build a
revolutionary aircraft to offer a revolutionary flight. According to Boeing, the design
teamstudied commercial flight very carefully to identify how this airplane could
strengthen theaviation business. The 787 Dreamliner is designed to carry
passengers for at least 30 years.During that period, interior styles will likely to
change several times. Seats, lavatories,galleys and in-flight entertainment systems
all has been designed to easily accommodateupgrades and replacements. Design
team worked with cabin component suppliers todevelop standard mounts and
interfaces that will enable quicker and more economicalmodifications. This way,
airplane owners can expect higher lease and resale valuesthroughout the
787 Dreamliner’s lifecycle
Fuel efficiency:
787 Dreamliner is more fuel efficient than comparable earlier airliners, it isthe first
major airliner to use composite material for most of its construction (in addition
toadvanced aluminium alloys), making it lighter for its capabilities. Because
composites do notsuffer fatigue from repeated stress the Dreamliner can be
pressurized to the equivalent of6,000 feet of altitude.A350 airframe will be built of
weight-saving advanced materials like carbon fibre-reinforcedplastics (CFRP) and
aluminium lithium alloys, according toWide body Aircraft Parade. Thenew aircraft
will be the first Airbus product with an all-composite wing. The rear fuselageand the
tail cone will be constructed from composites, as well. Boeing intends to make
50%of its 787 Dreamliner out of hardened plastics and therefore lighter and more

5. fuel efficient.Airbus has been planning to build much of the A350 with aluminium
alloys.
Noise-Reduction:
Boeing experimented with several engine noise-reducing technologies forthe 787.
Among these are a redesigned air inlet containing sound-absorbing materials
andredesigned exhaust duct covers whose rims are tipped in a toothed pattern to
allow forquieter mixing of exhaust and outside air
.
Engine:
the new A350’s engine
s will be more advanced than those on the 787 with thrustranges between 75,000
and 95,000.The primary goal of all of this design-related function is to promote
passenger comfort,make the journey direct, simple, cost effective and comfortable.
Also for the aircraft to:
Limit environmental pollution
Produce less noise
More space
Lighter and fuel efficient
High lease and resale value
Changeable interface
.

6. that two-actor markets willeventually evolve into a one dominant technological logic.
But this is not always the case.This paper shows that in the aircraft industry, firms
are obliged to deal not only with hightechnological barriers, but also growing
financial and market barriers. In order to reducethese, a complex network of
relationships has developed over time. This network involvesboth main firms
belonging to the world oligopoly and firms capable of offering specialisedtechnology
and/or a potential broadening of the market. The result is a worldwideproduction
organisation.In regards to the commercial aircraft market, economists predicted the
duopoly market willcontinue between 2007 and 2016. The estimated Boeing and
Airbus production share is 56%and 43% respectively and the remaining 1% is
shared between Russian companies andUkraine. Despite these predictions there
are signs of
possible threats from various new entrantsto the current duopoly
. Growing international competition is emerging from markets inChina, Brazil and
Russia, also from Bombardier Aerospace which is competing for a marketshare from
Airbus and Boeing. According to economist experts, China has gained
adequateexperience and competence to challenge the duopoly and is planning to
build a wide bodyaircraft along with Russia. Both
Post-Paris Air Show and the Dubai Air Show held in 2007 hasmarked a growing
global competition in the commercial aircraft market.
Regardless of global attempts to enter the market, Boeing and Airbus will remain the
twobiggest players for the foreseeable future because they enjoy: long experience,
advancedtechnology, government support, loyal clients, network of suppliers and
resources. Buteventually the rising global companies will gain shares in the market
and transform it tooligopoly market.
History of trade dispute between Boeingand Airbus: An overview
Until 1980, US commercial aircraft industry enjoyed a de facto
monopolistic position in the world market, despite the European-based Airbus
Industry having come to exist in 1970.2 The US dominant position, with two US
commercial aircraft manufacturers, Boeing and McDonnell Douglas together,

7. accounting for more than two-thirds of the world market share, continued till as
late as the mid-1990s. With Boeing deciding to acquire McDonnell in 1996, it
was expected that the position will improve further. Surprisingly, this
formidable position came to be challenged by Airbus, which since 1981, contrary
to its initial perception of having been regarded as only a marginal competitor,
was progressively increasing its market share. By early 2000s, Airbus was
consistently garnering a larger share of new orders than Boeing, and in 2003, it
even surpassed Boeing for the first time in deliveries of aircrafts (305 deliveries
by Airbus as against only 281 by Boeing).
* The author’s review of the Boeing-Airbus trade-dispute is mainly based on the
details of the case specified in Hill (2005)1
The phenomenal success of Airbus was not received well by many in the
US who attributed it to the fact that it was due mainly to the huge subsidies it
received from the government. This was followed by a chain sequence of
accusations and counter-accusations. Somehow, under an agreement in 1992,

8. the two sides agreed to make some allowances to each other. The agreement
allowed Airbus to receive some launch aid from EU governments (Great Britain,
Germany, France and Spain), and Boeing to benefit from government R & D
contracts. Under the agreement, direct government subsidies were limited to 33
per cent of the total costs of developing a new aircraft with the condition that
such subsidies had to be repaid with interest within 17 years. But the agreement
did not last long. In 1997, the agreement broke down when the European Union
decided to challenge the merger between Boeing and McDonnell Douglas on the
ground that it limited competition. Boeing’s plea was that the merger was
necessary to strengthen its presence in the defense and space side of the
aerospace business areas where McDonnell Douglas was traditionally strong.
After the two sides listened to each other, the dispute between the two appeared
to have settled. But soon after, the Airbus executives, who had initially stated
that they had no objections to the merger, gradually started opposing the merger
again and became increasingly vocal in their pronouncements. Trade tensions
between them erupted yet again in 2004. This time, the US questioned the
appropriateness of Airbus receiving the launch aid even as it had consolidated
its position in the world market. To this the Airbus responded with the
accusation that Boeing was still benefiting from subsidies. No break-through
was seen in the dispute. To add fuel to the fire, the British government decided
to announce even a fresh dose of aid ($ 700 million) to the Airbus in mid-2005.
The US dissatisfied with these developments formally filed a request with the
WTO for establishment of a dispute resolution panel. The EU, on its part,
quickly reacted and filed a countersuit with the WTO claiming that US aid to
Boeing exceeded the terms set out in the 1992 agreement.
Main issues of contention and their merit

9. Looking back at the history of trade dispute between Boeing and Airbus,
I may summarize and comment upon the main grievances, arguments and
counter-arguments of this case as follows:
The most convincing grievance of Boeing (which was consistently losing
its business to Airbus) was that Airbus received huge subsidies, between 1970
and 1990, in the form of loans at below-market interest rates and tax breaks
which together amounted to $ 25.9 billion. This benefited Airbus in two major
ways. One, its R&D became a highly subsidized, hence, a high-voltage
innovative program with extremely favorable cost and quality implications, and
thereby, a competitive edge in the market. Two, it also provided a financial base
to the Airbus which was strong enough to enable it offer its aircrafts to its
customers on highly attractive terms of credit – credit to the extent of 80 percent
of the aircraft cost for a term of 8-10 years, at approximately 7 percent interest
rate. This was quite in contrast as compared to the credit provisions in the case
of Boeing. The US Export-Import Bank supplied credit for purchase of Boeing
and McDonnell Douglas aircrafts – 20 percent down payment, and credit against
only 40 percent of the aircraft cost, the remaining 40 percent to be financed by
private banks at an average interest rate of about 8.5 percent for a period of 10
years. Apparently, the two competitors cannot be said to be on a level playing
field with regard to the availability of credit support to their marketing efforts.
But there is other side of this issue, as well. a little reflection on which would tilt
the scale in favour of Airbus. We will turn to it a little later. Let us first see what
the contention of Airbus was in this regard.
The main reaction of Airbus to the said objection of Boeing was that its
success was not due basically to the subsidies it received, but to its
state-of-the-art technology, and strategic production and marketing vision.
Strategically, it concentrated initially only on market segments not served by
new aircraft or not served at all. As this position of Airbus appears to be based
on facts which are of objective nature and verifiable, the grievance of Boeing,

10. expressed in the disguise of unequal credit terms, is possibly the expression of
disgust over its failure to protect its market share and retain its hegemony in
the market. Even otherwise, the main issue of trade rift between the two cannot
be said to be the government aid. If Airbus received subsidies, so did Boeing, too.
If at all, the blame with regard to the subsidy controversy lies with any one, it
lies first of all with Boeing, and then with the governments, on the two sides.
If we evaluate and compare the subsidies availed by Airbus and Boeing,
there is a major difference between Airbus subsidy and Boeing subsidy. The
Airbus subsidy has been in the form of repayable loans with interest for aircraft
development, which is legal according to the World Trade Organization. The
Boeing subsidy, on the other hand, has been for aircraft production, which is
prohibited by the WTO and which is never required to be paid back. This fact is
duly supported by a research conducted at the Canada-United States Trade
Center in the UB Department of Geography3. If someone is to lose the case on
this ground, it is Boeing. Is Boeing ready to payback the subsidies and accept
self-financing arrangement to cover for the areas funded by subsidies?
Secondly, it is quite intriguing as to why government aid continues to be
allowed even after these giants have matured enough to be able to find out to
stand on their own strength. To me no argument (in favour of any further
continuation of aid) - employment-based, or BOP-based, or even the one that
derives its strength in the name of national pride - is acceptable to me.
Watching this episode from heaven, Hamilton and List, would have
wondered over the wrong empirical side of the Infant Industry Argument they
put forward in support of players competing on unequal levels! According to the
infant industry argument, it makes sense to extend temporary support to such
domestic industries which are crucial to the general wellbeing of the people of
the country and which cannot compete with its giant competitors for want of
level playing field. It is a historical fact that the world’s three market economies
- USA, Germany and Japan - all began their industrialization duly assisted by

11. their respective governments through various types of trade barriers. This
argument seems fine, highly plausible and convincing. Many governments have
seen merit and conviction in this argument. But there are instances when
governments, both in developed and developing countries, have made its
extensive use to defend their, otherwise unjustifiable, anti-free-trade policies.
Protectionist measures, tariff or non-tariff, are justifiable only as a
temporary support. But experience has shown that in most countries, the
shelter behind these restrictive trade practices became mostly a perpetual
phenomenon (look at the classical case of agricultural subsidies in India).
Subsidies, beyond a particular stage, may do no good if these fail to make the
industry really competitive and self-reliant. Even after decades of basking under
the comfort of subsidies, both Boeing and Airbus, and sadly, even their
respective governments, still continue to regard their continuation
indispensable.
The following are the main arguments that have been put forward in
support of continuation of subsidies, in this case:
 High development costs: The costs of developing a new airliner are
estimated to be between $ 5 billion to $ 15 billion for various
categories of aircrafts.
 High break-even level: Given such enormous development costs, a
company must procure a substantial market share to break-even.
It has been estimated that the break-even in the case of commercial
aircraft industry may not be expected before 15 years or so, given
the demand and production projections.
 Volatile demand: The commercial airline business is prone to
cyclical behaviour. As experience shows, in the recent past, many
major airlines suffered from falling demand and went bankrupt,
although there were other, less important, reasons, too.

12.  Substantial experience curve levels: In aircraft industry, a
significant experience curve exists on the manufacturing side. It
has been estimated that the positive economies, induced by
experience and learning acquired during sustained production
tempo, produce a significant reduction in unit cost – with doubling
of accumulated output the company enjoys a unit cost advantage to
the extent of 20 percent. Conversely, it means that if a company
achieves only half of the market share required to break-even, it
will suffer a 20 percent cost disadvantage.
There can be hardly any dispute with the merit of these arguments. But one
thing is not clear. If the two commercial aircraft companies are expected to be
competitive and profit-making in the long-run by their respective governments,
and further, if they are regarded worth developing through subsidies and other
protectionist measures, why should the government not leave them to the total
care of the private sector; why should it assume any responsibility for itself, in
this regard? To counter this suggestion, it may be argued that the investment
involved is on an enormous scale, and for a long period, and above all, it is
exposed to the adverse effects of demand uncertainties. This argument surely is
not convincing. If at all, it implies any thing it is as follows: Only the productive
resources owned by the private sector have an opportunity cost, so do not let
them be wasted. The resources at the command of the government are no body’s
money (the tax-payer!), so why care for their opportunity cost. Moreover, the
argument that private investors take into account only the current returns in an
industry and fail to take account of the future prospects is not consistent with
investor behaviour in advanced countries, particularly where the latter are often
observed to back projects whose returns are uncertain and lie far in the future.
(Consider, for instance, the US biotechnology industry, which attracted
hundreds of millions of dollars of capital years before it made even a single
commercial sale)4.

13. Realityof the situation
On the strength of these arguments, one would tend to agree with the view of
the analysts in this area that the world market for commercial aircrafts can at
the most support the presence of three major producers. In my assessment,
recognition of the oligopolistic nature of global commercial aircraft market must
be accompanied by acknowledgement of the self-defeating outcomes of
individually-centered, non-collusive strategies adopted by firms in such
industry. This is what Boeing and Airbus has to learn from Cournot’s model in
which oligopolistic firms are portrayed behaving in an extremely naïve, if not
stupid, manner, and never learning from their past mistakes. As a result, they
finally land themselves in a collectively disadvantageous position. In such case,
respect for mutual interdependence and acting in a coordinated way is in the
interest of both. More or less, similar are the implications of other
non-collusive behavior models, for instance, Stackleberg’s model (the
leader-leader case).
Conclusion
The substance of this review of the case, in question, is that firms, such as
Boeing and Airbus, operating in an oligopolistic market environment should not
be ‘misled to be competitive’ by way of granting legitimacy to their clamour for
subsidies, direct or indirect. This is patently unjustified. This amounts to
frittering away scarce productive resources for which policy makers owe an
explanation to the tax-payers. The sooner the two giants in the arena of global
commercial aircraft market see the writing on the wall and adjust themselves to
the reality of the market scenario and assimilate its culture of co-existence (in
terms of leadership acceptance, or market sharing, or adopting limit-pricing
behaviour so as to keep potential entrants at bay), the better it is for them and
their countries. In no way, this perception may be construed to imply a
competition-limiting approach. The fact is that in this particular case, any
attempt of acquiring a competitive edge by one side on the other is most likely to

14. induce a chain sequence of actions and counter-reactions, arguments and
counter-arguments. Ultimately, it is detrimental to their own interest as well as
to the interests of their customers. Both Boeing and Airbus spend billions of
dollars for buying aircraft parts and sub-assemblies such as avionics and
landing gears. So, frequent trade war can be more deteriorating than just
affecting the airline customers. In any dispute between two parties when
insinuations and allegations replace logic, when the mediator (like
grievances-redressal mechanism of the WTO) lacks the necessary teeth to
ensure compliance of its norms and rulings, and when even the governments
lose objectivity and vision, solutions are not easy to seek. Given, sincerity of
purpose and sagacity, the solutions are not difficult, either.
U.S should explore the options of expanding its target market to other
emerging foreign markets like Vietnam and Iran5. Current export controls in
U.S. prevent Boeing from entering these markets. They also affect Airbus sales
through re-export constraints. Airbus can lower the U.S content by the
introduction of Rolls Royce engines in place of the manufactures Pratt and
Whitney and General Electric. The two companies should look for ways of
comparative advantage by looking at the use of cost effective and more
specialized products and services produced by other country to bring in
operational efficiency through scale economies. For example, Western Europe
holds a competitive advantage with respect to Wind Tunnel capability.
References
1. Hill, Charles W. L. (2005), International business: Competing in the
Global Market Place, Mcgraw-Hill.
2. http://ec.europa.eu/trade/issues/sectoral/industry/aircraft/index_en.htm)
3. http:// igeographer.lib.indstate.edu/pritchard.pdf

15. 4. Krugman, Paul R. (2003), International Economics, Pearson Education,
Inc.
5. Global Competitiveness of U. S. Advanced-Technology Manufacturing
Industries- By DIANE Publishing Company