Section A

The market currently at equilibrium can be shown as

Where Qeq and Peq are quantity and price at market equilibrium.

When the report suggesting consumption of coffee is good comes out. Assuming that all people
want to become healthier, the demand for coffee is rise. And hence Demand denoted by D will shift
towards D’. The supply remaining the same will yield us a new market equilibrium at Q’ and P’
respectively.

Sugar is a complimentary good to coffee, therefore changes occurring in the sugar market will bear
an effect on the coffee market as well. Since the price of Sugar will increase it will in turn increase
the price of coffee which will decrease the demand of coffee in the market. Thus, we have reached a
new market equilibrium at Q” and P” respectively.

Section B

Given that the specific location that has been selected is the Bristol airport it makes sense to
understand the market conditions of an airport such as the Bristol airport. There are 12 competitor
airlines to consider before entering the market. The largest being easyJet with a fleet of 17 aircrafts.

Such a scenario is an oligopoly. There will be interdependences between the competitors as any
change in the environment will in turn have a large impact on the changes that will occur to the
operations of the competitor’s business.

Now, given that Rolls already have their own factory in Bristol and are also planning to operate in
the Bristol airport. It makes most sense then to understand the number of units that would be
needed to operate in the airport at a profit. Therefore, the output is of prime consideration.

Therefore, the Cournot Model of Oligopoly offers us a useful view of such a market given our
requirements.

Let us consider first a situation in which the existing competitors in the market be treated as a
monopoly and work our way towards the entry of Rolls in the market.

To understand the output that we will be required to put out let us for simplicity’s sake keep the
Marginal Costs of all firms at a minimum. Practically also, to compare the marginal costs of Rolls to
its competitors would not be of much help considering the cost of production of an airplane for Rolls
will be considerably less given that they produce their own engines and that all other competitors in
this market do not currently own an aeroplane engine business.

Considering this as the equilibrium for all firms before the entry of Rolls. With PC and QC as price and
quantity of all competitor prior to entry of Rolls.

Now, when we introduce a new competitor, in the given scenario – Rolls, There will arise changes to
the products demanded which will in turn impact the share of Rolls’ output.

Given that we are output based and working within the Cournot model, two concepts need to be
looked at to provide a theoretical understanding of the future profits. They are:

1. Cournot Conjecture: Rolls must calculate it’s output strategy based upon the current trends
of all competitors in the market.
2. Residual demand Curve: Rolls can capitalise on the demand that is left over after the
competitors have provide for output at the equilibrium price and output.
The Residual demand curve then, for Rolls, is that which is denoted by Blue in the figure above.
Meaning, that there are those in the market unable to participate at the equilibrium price and
quantity. The ideal strategy for Rolls then would be to capitalise on this residue in demand that is
left over but below the equilibrium price.

Then considering the demand that Rolls will have captured we can project our own Marginal
Revenue for that specific given residual demand. Thus, the quantity that Rolls will have to produce
upon entry is QR as denoted in the diagram.

But this is only for the scenario of entry in the airlines market of Bristol Airport. We must now
consider, what will happen once Rolls has finished entry. There will be a correction in action on part
of the competitors due to the interdependences of an oligopoly.

The other competitors in the market will then consider the quantity that Rolls will be producing, and
thereby adjust their output for the market. Why? This is because if they would have produced at the
rate that they were already producing, they would end up in a loss as the last numbers of aircrafts
that’ll be used in the airport would have already been taken up by Rolls. Therefore, resulting in a
redundant amount of aircrafts for the competitors.

Now, for our scenario it is important that we understand the market conditions post entry into the
market as well and post corrective measures by the competitors.
The competition will consider only the residue of demand after taking out the demand that would
have already been taken by Rolls. They will therefore have a new marginal revenue denoted by MRC’
and they will be selling a quantity of QC’.

This is a process that will repeat again from Rolls’ perspective as well as from the perspective of its
competitors. Therefore, sequentially adjusting one by one until all parties within the market reaches
an equilibrium. In such a scenario it will be called a Cournot Equilibrium.

We can now try and understand the market equilibrium and how we will reach there by
understanding the best response function that all competitors versus Rolls will need to take.

One thing to note is, if Rolls would want to be the market dominator then they would have to
produce a quantity of QRmax .

A similar best response function can be drawn up for Rolls as well.

When we develop the best response functions for all competitors versus Rolls in the market, we can
begin to understand the equilibrium that would be achieved in this Cournot scenario.

Therefore, before entry into the Airlines Market of Bristol Airport, it would behove Rolls Royce to
look at the various numbers of corrections it would have to do to achieve profitability while
remaining in equilibrium in the new market. Even though MC have not been considered, the costs
would be easier understood in line with the production costs of an airplane, minus the cost of an
engine as they would be able to provide one by themselves. Thus, freeing up revenue for them to
invest more into the market and make an impact.