Ryanair is one of the largest and fastest-growing airlines in the world. It started flying in 1985 and, after an initial brush with financial problems in 1990, found its key to success: building a cost structure so low that its European customers, who were accustomed to dowdy and expensive national carriers, started flying Ryanair all over the continent. Ryanair’s total passenger traffic increased by a factor of 22 between 1997, when it launched routes outside Ireland and the United Kingdom, and 2013. In the five years from 2008 to 2013 alone, the number of passengers Ryanair carried grew by 23 million. To put that in perspective, this additional number of passengers equals about one-third of all airlines’ traffic in 2013 at London’s busy Heathrow Airport.
Ryanair’s cost-conscientiousness is famous. To save landing fees, it rarely flies to a city’s main airport. Instead, it flies to secondary airports often located far away from the main city. (For example, its flights to Frankfurt, Germany, arrive at Frankfurt Hahn Airport, 78 miles [126 km] from Frankfurt’s city center.) Its pilots are only allowed to load the legally mandated minimum requirement of fuel for each trip. The seats on its planes don’t recline; the way Ryanair sees it, that’s just a source of unnecessary maintenance costs. Nor do the seats have tray tables or seatback pockets—too much extra weight means extra fuel. Ryanair has discussed squeezing in six more seats on each plane—by getting rid of all but one of the plane’s bathrooms. You better check yourself in for your flight online, at least two hours early; it costs €70 (about $80 in 2015) to do it at the airport. (Ryanair doesn’t employ a lot of desk agents.) To keep it simple, Ryanair only handles point-to-point itineraries. If you want to make a connection, you have to book two different tickets. And if you miss your connection, even if you missed it because Ryanair was at fault for your first flight being late, you have to buy a new ticket. This last rule might seem harsh until you realize that some of the airline’s flights cost as little as €10 (about $11.50) each way.
7.1 Costs That Matter for Decision Making: Opportunity Costs
7.2 Costs That Do Not Matter for Decision Making: Sunk Costs
7.3 Costs and Cost Curves
7.4 Average and Marginal Costs
7.5 Short-Run and Long-Run Cost Curves
7.6 Economies in the Production Process
Flying Ryanair isn’t for everyone; comfort and customer service aren’t its specialties. But the Ryanair example raises an important point: Costs are key to firms’ operations, and a firm’s cost structure is a crucial factor in its production decisions and in determining whether it makes a profit. Costs play a crucial part in determining a firm’s optimal output level, how much the firm should grow or shrink in response to changing market conditions, and how easily it can start producing another product if it wants to.
We started to look at a firm’s production cost at the end of Chapter 6 when we introduced the expansion path (which shows how a firm’s optimal mix of inputs varies with total output) and the total cost curve (which shows a firm’s cost of producing particular quantities of output). These two concepts provide the foundation for understanding a firm’s cost structure. It is vital for a firm to understand what its costs are and how they change as output changes. That’s key for economists, too, who want to understand why producers act the way they do, and it is the key to explaining where supply curves come from (a topic we explore in Chapter 8). In this chapter, we examine the nature of a firm’s costs by considering how a firm’s production function and level of output determine its costs, given the prices of its inputs. We also consider how a firm’s costs vary between the short run and the long run.