Under which market structure would you classify the airline industry? Given this
ID: 1195384 • Letter: U
Question
Under which market structure would you classify the airline industry? Given this structure, why is it that there is little price competition between carriers on the same route? Why is there not more price competition? If they do not choose to compete on price in most cases, how do they compete with one another? What strategies do they employ ? Under which market structure would you classify the airline industry? Given this structure, why is it that there is little price competition between carriers on the same route? Why is there not more price competition? If they do not choose to compete on price in most cases, how do they compete with one another? What strategies do they employ ?Explanation / Answer
The market structure for airlines is an oligopoly. This means that there are only a handful of companies that compete in this industry. Oligopolies are more competitive than monopolies, industries for which there is only one seller of the product, but are less competitive than industries that experience near perfect competition. Before discussing how oligopolies work, a few words about monopolies and perfect competition...
A monopoly exists when one seller is the only seller of the product or service. Some industries are prone to become monopolies naturally, and because the industry operates more efficient with one provider, they are allowed to become a monopoly but are regulated to keep the company from exploiting the buyers. For instance, electric companies are generally natural monopolies. Since it would not be worth it for a competing electric company to lay their own electrical lines all the way to your house when you might not even switch to them, only one company controls the electricity that sells to your house. It's more efficient that way, and the government allows this type of monopoly while regulating the price this company sells electricity to you. Some other industries, such as steel and oil, once become powerfully monopolistic over a hundred years ago. These monopolies were formed in ruthless ways, which destroyed other companies and then exploited buyers with high prices. Eventually, the government broke apart these monopolies and passed anti-trust laws to prevent future monopolies.
On the opposite end of the spectrum is perfect competition. Perfect competition is pretty much just a theoretical concept and never actually exists, but some industries can come very close to perfect competition. Some items sold on eBay approach perfect competition. Suppose people on eBay are selling a book for which there are many, many sellers selling identical editions of the same best-selling book. Adding in shipping and handling, you will find that people are all buying the book for almost the same price. An eBay seller could not sell the book for more than that price, and people will bid up the price to the going price. Each individual seller sells the book at a price set by the market and has virtually no power to set prices.
In the middle are oligopolies. In an oligopoly, each company has some pricing power, but they can't set prices to whatever they want. Each company affects the market (unlike perfect competition) but is also affected by other companies in the market (unlike monopolies). Oligopolies are industries where set-up costs are extremely high, so people can't just enter the market even if there's money to be made in the industry. Imagine trying to start a new airline to compete with United or American. It would be extremely difficult. (On the other hand, one could start an eBay business rather easily. Even a family restaurant is relatively easy compared to a new airline.) The same would be true of starting a car company. In oligopolies, people will sometimes refer to the "Big 3" or "Big 4" or "Big" however many major players there are in the market. That's not to say that there aren't small players in the airline or automotive industries that fill a special niche in the market, but the small companies don't affect the major players.
One characteristic of oligopolies is that they engage in price wars. When one airline company decides to cut fares or one car company decides to cut new car prices, the other industries will usually cut theirs as well. Price wars happen because some company is trying to grab a larger percentage of the market, and the other companies lower their prices to not lose market share. With oligopolies, people feel some loyalty for various reasons (such as frequent flyer program or availability of certain flights), so people might stick with their preferred company when a competitor offers a lower price, so just because one company is selling at a higher price doesn't mean they won't sell at all. (On the other hand, a company in perfect competition will sell no units if its price is higher than other companies in the market.) However, if the price difference between oligopolistic companies is great enough, virtually everyone will ditch the higher price company and buy from the cheaper company.
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