Summary: Although the airline industry is dominated by a relatively small number of large firms, such as Delta Air Lines and American Airlines, 65 little-known regional carriers account for 40 percent of all passengers. Recently, some of the smaller airlines have been acquired by larger airlines, which have increasingly taken over small-jet fleets that they lease to their regional partners. One result of this is that more passengers are being shifted to the preferred hubs of the large airlines and away from smaller airports.
Classroom Application: The airline industry has an oligopoly market structure in which a relatively small number of firms account for a relatively large share of passenger ticket sales. Unlike a competitive market in which many firms have little or no power to set the prices of the products they sell, each oligopolist has enough power to increase or decrease its own prices. But other firms in the industry are likely to react to such price changes. As a result, there may be price competition in some oligopoly markets, but little in others where firms fear the impact a price war would have on their revenue and profits.
Questions:
- Oligopoly markets have entry barriers that make it difficult, but not impossible, for new firms to enter the market to compete with existing firms. Name an entry barrier that would make it difficult for a new firm to enter the airline industry.
- The article mentions that the airline industry was subject to government regulation prior to 1978. This regulation limited the prices airlines charged for passenger tickets. How can airlines compete with each other when price competition is limited by regulation?
- Since 1978, an airline has been able to charge different prices than another airline that flies the same route. On what type of route would price competition be most likely? On what type of route would price competition be less likely?
- A typical airline flight has relatively high fixed costs and very low marginal costs. Explain why the fixed cost of a flight from New York City to San Francisco is high. Explain why the marginal cost of this flight is low.
- The article mentioned that a regional carrier, Mesa Airlines, “…returned to the stock market last year following a 2010 bankruptcy.” How would declaring bankruptcy assist Mesa Airlines’ return to the stock market?
- From the article: “Mesa [Airlines] stock trades at 4.3 times earnings, less than half the average of the industry.” What does trading “at 4.3 times earnings” mean?
- Would investors be more or less likely to purchase shares of Mesa stock because it trades at “less than half of the average of the industry”? Explain briefly.
- “Economists have long found that market power tends to reside in the party that controls capital expenditure…” To what type of capital expenditure does this refer?
- The article mentions that many planes that have 50 seats are becoming older and suggests that United and other major airlines would like to replace these with larger planes that have as many as 90 seats. Why would the airlines prefer to fly planes with more seats? Why would airline workers’ unions be reluctant to agree with this proposal?
- “Both SkyWest’s and Mesa’s operating profit margins now surpass those of all major U.S. airlines…” How were two small, regional airlines able to have profit margins greater than the operating margins of each of the larger airlines?
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