Question

An air cargo company must decide how to sell its capacity. It could sell a portion of its capacity with long-term contracts. A long-term contract specifies that the buyer (the air cargo company's customer) will purchase a certain amount of cargo space at a certain price. The long-term contract rate is currently $1,875 per standard unit of space. If long-term contracts are not signed, then the company can sell its space on the spot market. The spot market price is volatile, but the expected future spot price is around $2,100. In addition, spot market demand is volatile: sometimes the company can find customers; other times it cannot on a short-term basis. Let's consider a specific flight on a specific date. The company's capacity is 58 units. Furthermore, the company expects that spot market demand is normally distributed with mean 65 and standard deviation 45. On aver- age, it costs the company $330 in fuel, handling, and maintenance to fly a unit of cargo.
a. Suppose the company relied exclusively on the spot market, that is, it signed no long- term contracts. What would be the company's expected profit?
b. Suppose the company relied exclusively on long-term contracts. What would be the company's expected profit?
c. Suppose the company is willing to use both the long-term and the spot markets. How many units of capacity should the company sell with long-term contracts to maximize revenue?
d. Suppose the company is willing to use both the long-term and the spot markets. How many units of capacity should the company sell with long-term contracts to maximize profit?


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  • CreatedMarch 31, 2015
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