South-Western EconNews: Capped Commissions Cause Travelers' Unrest

Capped Commissions Cause Travelers' Unrest

Subject

Short-run and Long-run Equilibrium

Topic

Perfect Competition

Key Words

Commissions, Margins, Fees, Price, Costs

News Story

Air fares are expected to rise indirectly as a result of the decision of the major airlines to impose a limit of $100 on travel agency commissions for booking international flights. Previously, travel agencies received 8 percent, which on higher fares came to more than $100. This change follows the recent cut in the commission from 10 to 8 percent, and the 1995 introduction of a cap of $50 on a round-trip domestic ticket.

As travel agencies find their margins squeezed, some are expected to go out of business while those that remain can be expected to increase fees for service. Currently, $10 to $15 is charged on average by 64 percent of members of the American Society of Travel Agents.

Leisure travelers will see the total price of purchasing a ticket rise. Business travelers will be hit most. Businesses -- which pay travel agents a management fee in return for refunds of the commissions -- will see their net costs increase. In the meantime, United Airlines expects to save approximately $100 million, while Delta Air Lines may save $40 to $45 million each year.

(Updated February 1, 1999)

Questions

1.	How does the market for airline tickets approximate perfect competition?
2.	Draw a set of two diagrams representing the perfectly competitive airline ticket industry and a representative travel agency. Show the travel agency breaking even.
	a) The capping of agency commissions can be treated as an increase in input costs for travel agencies. Illustrate what happens in the short run in the industry diagram and in the travel agency diagram. Mark what happens to the effective price of airline tickets. Also show what happens to the number traded and to the amount of profit.
	b) Why does the amount of profit change in the manner that you have drawn?
3.	In the long run, what will happen? Illustrate on your diagram. What will happen to the equilibrium price and quantity of tickets? How will the level of profit change?

Source

Edwin McDowell, "An airline limit on travel agency fees for overseas flights may cost the flying public millions", The New York Times, November 25, 1998.