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First things first: a vacation package is not an escorted tour, where they shuttle you around Europe in a hermetically sealed bus bubble of Americanism.
With a packaged vacation, your trip is entirely your own—you just don't have to book everything (airfare, hotels, maybe rental car or sightseeing) independently. You get some combination of those big-ticket items all at once and for less (ideally) than you'd pay if you tried to book them separately.
That is because a single company is reserving the air and hotel (or the air and rental car, or the hotel and local tours and sightseeing) on your behalf as a bundled "package." Packagers leverage their buying power to secure airfares, room rates, rental car prices, and local tours at a discount, then pass some of those savings along to you (they keep some, of course; that's their profit).
Although, in industry-speak, whenever any two travel items are booked together it is technically a "vacation package," in practice a true packaged vacation is when you get at least two of the big ticket, high-priced, major parts of your trip all at once—usually transportation (air and/or rental car or railpass) and lodging, or lodging and sightseeing.
There are three major kinds of these packages, each described in full on its own page:
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