This report will introduce an overview of recent changes to the airline industry supply and demand conditions and will also include the industry concentration ratio. The report will state the extent and nature of barriers to entry and exits of the industry and show account of the structure of competition taking place between airline companies. To conclude, the report will explain and evaluate the regulation of anti-competitive behaviour within the airline industry.
The airline industry provides consumers with air transportation that improves our lives by shortening the time it takes us to reach a destination as well as delivering goods. The airline industry is an oligopoly market which involves a few airline companies in the competitive market, where similar services provided, however differentiate in the branding and the promotion of sales. There are four main categories in the airline industry, which is international, national, regional and cargo. International flights provide services between countries; both national and regional flights are domestic flights within a country, but regional flights have shorter distance compare to national flights; and cargo is mainly for the use of transporting goods.
Mathematical Notation of the Supply Function
q ns = S ( pn , F1…….., Fm)
There are a few determinants on the demand curve that will cause a change in the supply and demand curve in the airline industry. The first determinant is income; this is when a country experiences a growth in the economy, where the average income of the employed public will increase. Air tickets play a role as a normal good, due to an increase in the income will lead to an increase in the demand for tickets purchased. For example, families might travel more often as they are in good economic condition. In the diagram this situation would be D1, high P1 would lead a high Q1 “When incomes rise, the demand for most goods rises…for a normal good, demand rises when income rises” (Begg, 2013, p33). This is a reason why a shift to the right in the demand curve can occur. D2 with high P2 will lead to high Q2.
Appendix 1 source: (Begg, 2013)
The second determinant is prices of related goods, where a change in price of a good might affect the demand of the other good. In the industry the price of fuel has a direct influence on the demand of air tickets. The price of fuel increases due to external factors of the value of the good. The airline industry must increase the price of tickets to maintain its revenue. As a result, if P1 is high, Q1 will decrease. Therefore, the fuel price and demand of tickets have a relationship of complements, where increase of fuel price leads to a decrease in the demand for air tickets (Q1). However, in certain cases especially during a decline in the economy, the airline industry will not raise the price of tickets because the customers will buy elsewhere. This depends on the price of the competition. This will result of lower P2 would have high Q2. This evidence, the demand of tickets is also quite dependent to the condition of economy. This explains the responsiveness to changes in people’s income and prices which the elasticity goes higher (demonstrated in appendix 2) and changes in market conditions that affect the demand and supply of the airline industry (Krugman, 2006). Recently in “Britain’s economy expects to suffer more generally should oil prices continue to rise” (Inman, P, 2017) this can mean in airline companies will have to raise the price of air tickets to generate revenue or reduce costs elsewhere to keep the organisation in operation. Unfortunately, Monarch Airlines recently shut down in October 2017 due to ‘Brexit’ that lead to the fall of the pound. As the pound is now weaker, buying products from outside the UK will be more expensive. This has “left Monarch paying £50m a year more for fuel and aircraft” (Topham, G, 2017) which will not create enough revenue to survive in the industry and keep in operation.
Appendix 2 source: (Krugman, 2006)
The third determinant is the number of buyers. The more buyers in the industry, the demand for tickets will be higher. When a promotion is held by the airline industry, there will be more buyers for the purchase of tickets, as the tickets normally sell at a lower price to attract more customers especially during a not so peak season. Thus, the demands for tickets will increase and the airline industry will gain more profits even through the tickets are selling at a lower price because a greater amount of people will buy tickets. “A Demand curve shows the quantity demanded at each possible price, other things equal” (Begg, 2013).
Lastly, the final determinant of supply and demand is the expectation of future income and price. This means the prediction of consumers on how much they will earn and the value of a good in the future. For example, imagine if the economy has positive development (GDP), where people expect a higher income in the future, they might go for a holiday and shift the demand curve of air tickets to the right. “The office for national statistics said GDP grew just 0.2% in the first quarter of 2017, a marked change of pace from the 0.7% growth in…2016” (Allen, K, 2017). The UK economy is slowing and has an extremely low growth, as rising prices takes a toll on consumer spending due to the ‘Brexit’ vote. If the consumer realises there will be an increase in price of tickets in the future probably due to a peak season, the consumer will choose to purchase now rather than later. This will cause the demand curve to shift to the left. D1 to low P1 will lead to high Q2.
The calculation for the C4 ratio for the UK airline company market is 87%. This indicates the current level of competition is a competitive market and an oligopoly. With pricing can go up due to external factors; such as fuel pricing going up, this can cause changes on the developments of demand and supply side.
Appendix 3 source: (Academic.mintel.com.stmarys.idm.oclc.org, 2016)
The barrier of entry and exits are when oligopolies and monopolies companies maintain their position in the market. There are many natural entry barriers, the factors can be from too costly or difficult to enter. Factors include:
· Economics of scale production.
· Ownership of a key scarce resource.
· High set up costs.
· High research and development costs.
The airline industry has a high barrier of entry. Barriers to entry in the airline industry include high set up costs, legal requirements, brand loyalty and economics of scale. High costs to start an airline company are one of the major barriers to entering the airline industry. The barrier cost starts with aircrafts because of finding the capital to fund the investment; the cost of research and development; the demand of fuel is growing making it an expensive commodity and the cost of experienced pilots and flight staff to be trained can also be costly. In addition, the airline company will have to pay fees at the airport and they must get the CAA to approve routes they can travel. Also, the approval with insurance, banks and capital investors is high cost barrier making it difficult enter and leave the market. The barrier of exit is the costs such as heavy investments of equipment’s (jets) also reputation of the brand which is the sort that cannot be readily adaptable to another industry which are not easily recoverable, due to resources being specialised and therefore can be a risk to capital. For example, Monarch Airlines exit had to return funding to creditors, pension funds and stakeholders and also their brand reputation as “MPs have raised concerns that Greybull could profit…while the taxpayer loses out” (Partington, 2017).
The contrast of the models of imperfect competition market are the following market structures that have a unique set of characteristics such as perfect competition; oligopoly, pure monopoly, monopolistic competition. Perfect competition has many sellers and monopoly is the sole supplier of an industry’s product and potentially the only supplier, it’s sell product has a high entry and exit barrier and does not have similar substitutions. Examples of products in monopoly market are electricity and water. However perfect competition in market, has many sellers and monopoly with just a single seller in the market structure which are polar extremes of each other. Under perfect competition, there is no restraint to entry of new firms to the business or exit of the firms from the business. Furthermore, monopolistic is “an industry with many sellers supplying products that are close but not perfect substitutes for one another. Each firm has a limited ability to affect its output price” (Begg, 2013). Pure monopoly is protected by some form of barrier to entry, for example in the rail industry where there is one firm who deals with the whole industry, where consumers don’t have ability to have choice but use that firm. “demand curve for the firm is the industry demand curve itself. There is only one firm in the industry and it has no fear of entry by others” (Begg, 2013).
The airline industry is an oligopoly market; it exists when a few firms are competing in a market by selling related products and the barriers to entry are less than monopoly but are significant. For the example in this market are cigarettes and automobiles. There is also a possibility that oligopoly will have imperfect availability of information same with the monopoly market, the oligopoly firms will limit new entrants into the market. The types of barriers to entry are the control of resources, ownership of patent and copyright, financial requirements and other legal barriers. Those large firms will produce products at excess production to drive the price down with an aim to drive new firms out of the market, and once the new firm is out of the market, the firm will reduce production capacity and increase price. The behaviour of oligopolistic companies is thought through price and quantity with the models of demand curve and game theory. Usually when a leading firm moves others will follow. This shows assumptions from managers of how rivals will act and how competitors will not follow.
Game theory is used to study how interdependent decisions are made. Game is a situation in which intelligent decisions are necessarily interdependent. For an example, British Airways decides to increase ticket prices. Other airline firms will not follow because they will have an advantage by attracting British Airways customers and selling more tickets. This suggests that the demand curve is elastic to an increase in prose, however is British Airways lowered their price then other airlines will follow to not lose out on market share. This is not beneficial to the industry as it can lead to price wars and result of firms losing profit. (Bamford, 2008). Furthermore, a large airline company could take action to prevent entries of new companies by flooding the market with promotions. Once the new company are out of the market, the large firms will reduce the production of flights and increase the price again. “Like poker players, oligopolistic have to try and second-guess their rivals’ moves to determine their own best action” (Begg, 2009, p.108).
Anti-competitive behaviour are strategies designed to limit the degree of competition inside a market and this can occur in business, government or religious practices that prevent competition in a market. The key concepts can be;
· Complex monopoly
· Predatory pricing
· Rent seeking behaviour (improving warfare of one but in expense of the other)
British Airways and Virgin Atlantic agreed to an illegal cartel in 2004 by fixing prices between August 2004 and January 2006. “BA executives colluded with Virgin Atlantic executives to secretly fix the price of fuel charges in an attempt to make hundreds of millions” (the Guardian, 2017). Virgin Atlantic was not fined but British Airways was forced to pay a £121.5 million in charges and issued a penalty charge of £148 million by the US Department of Justice (Guardian (2007).
In conclusion, the airline industry post Brexit is strongly impacted as UK airline companies are struggling due to the drop of the pound, as a result inflation of fuel prices can be difficult to keep in operation. The industry is quite unstable as the economy economic conditions fluctuate, which leaves companies in heavy competition with each other. Overall it is a high barrier oligopoly industry to get into as it involves a lot of costs to start a firm and creates a risk of price wars and tacit collusion which can result in reduction of profits, but can be successful is good game theory is played. In addition, the high barriers of entry have proven that new entrants will be less likely to enter the industry due to unhealthy competition.
Bamford, C., Grant, S and Walton S. (2008). Chapter 6. Market structures and competitive behviours in transport markets. OCR A2 Economics. Essex, Heinemann.
Begg. D., Fischer, S. and Dornbusch, R. (2013). Foundations of economics. 5th ed. London: McGraw-Hill Education.
Krugman, P., Wells, R. and Olney, M. (2006). Essentials of economics. New York: Worth Publishers.
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Inman, P. (2017). Oil prices soar to highest for more than two years after output cuts. online the Guardian. Available at: https://www.theguardian.com/business/2017/sep/25/oil-prices-output-cuts-uk-inflation Accessed 27 Nov. 2017.
Partington, R. (2017). Monarch owner accepts ‘moral obligation’ over repatriation costs. online the Guardian. Available at: https://www.theguardian.com/business/2017/oct/29/monarch-owner-accepts-moral-obligation-to-cover-cost-of-repatriation Accessed 5 Dec. 2017.
Topham, G. (2017). Monarch Airlines collapse: UK’s biggest peacetime repatriation under way. online the Guardian. Available at: https://www.theguardian.com/world/2017/oct/02/monarch-airlines-flights-cancelled-as-airline-goes-into-administration Accessed 27 Nov. 2017.
Walsh, F. (2007). BA fined £270m for price fixing. online the Guardian. Available at: https://www.theguardian.com/business/2007/aug/01/britishairways.theairlineindustry?INTCMP=ILCNETTXT3487 Accessed 1 Dec. 2017.