Managerial Economics & Business Strategy 8th Edition by Michael Baye,Jeff Prince

Exercise 7

Blue Skies Aviation is a manufacturer of small single-engine airplanes. The company is relatively small and prides itself on being the only manufacturer of customized airplanes. The company's high standard of quality is attributed to its refusal to purchase engines from outside vendors, and it preserves its competitive advantage by refusing to sell engines to competitors. To achieve maximum efficiencies, the company has organized itself into two divisions: a division that manufactures engines and a division that manufactures airplane bodies and assembles airplanes. Demand for Blue Skies' customized planes is given by P = 812,000 - 3,000 Q. The cost of producing engines is
and the cost of assembling airplanes is C a ( Q ) = 12,000 Q. What problems would occur if the managers of each division were given incentives to maximize each division's profit separately? What price should the owners of Blue Skies set for engines in order to avoid this problem and maximize overall profits?