Introduction It is easy for people nowadays to travel around the world because the Airline industry can provide fast and convenient service for the passengers. However, in the world with a lot of competition, it is not easy for the business to survive. In this essay, we will first describe the features of the market which determine its market structure and consider what the best market structure for the International Airline industry is. Then we will move on to the term of non-price competition and the three different ways in which airlines compete for a share of the market.
Lastly, we will explain why a perfect competitive firm is unlikely to make supernormal profit in the long-run by using the graph and also discuss why the International Airline industry can make supernormal profit in the long-run. Finding In economics, market structure is the best describe the type of each organisation with the way each of them behaves in the market. For these market structures, we focus on those characteristics of the firms related to the competition and pricing. Therefore, when economists determine the firm’s markets structure, they will look at its characteristics.
These are the key characteristics of the firms’ market structures: ? Number of firms in industry- it refers to the number of competitors in the same industry. ? Type of product- which are homogeneous, differentiated, or unique. ? Ease of entry into industry- It shows the possible level of the firms to entry into the market. ? Firms’ influence over price- It means the power of the firms to control over the price. ? Consumer knowledge of market- the level that consumer can reach the firms’ information. Now, the major market forms in the difference industries will be analysed: ?
Perfect Competition: under the perfect competition, there are a large number of buyers and sellers who have free entry to the market. The production of the market is homogeneous and the buyers have full information about that market. ? Monopoly: There is only one seller in the market and it is impossible for the competitor to entry this industry. Therefore, the monopolist has full power over the price. ? Oligopoly: It is characterised by a small number of the sellers. Although each firm has some pricing power, they could not set up their own price because one firm action can affect other firms.
It is also hard for new company to entry into the industry because of the high capital cost. ? Monopolistic competition: There are a large number of buyers and sellers and it is easy for them to entry into the industry. However, the products of each company are differentiated. As the characteristic of the market forms above, the Oligopoly is the market structure which best describes the International Airline industry. This means that there are a few numbers of large companies in this industry. The company action can be expected to affect every other companies especially regard to pricing.
For example, Thai Airline has the largest market share for the destination from New Zealand to Thailand. It proposes a price decrease from $ 1500 to $1300 on a round trip. Therefore, other companies have to match the lower fare to remain their market share. In this case, we can see that the action of Thai Airline affects other companies in the market. In Oligopoly, there is the cost barrier which make new competitor cannot entry into the industry. In the case of International Airline industry, we can see that the capital costs such as buying aircraft are very high so it is extremely difficult for new firm to entry into this industry.
From the description and the example above, we can conclude that Oligopoly can best describe the International Airline. Now, we move on to the discussion between price and non-price competition for the Airline industry and three different way in which airline compete for its market share. Price competition is a marketing strategy in which company uses to increase its market share. In this strategy, a company tries to distinguish its product or service from the competitor by lower the price. “It is logical to assume that a firm wishing to sell more goods or service will drop its price.
At a lower price, the quantity demanded by consumers will increase” (James & Keith, 2008, p. 139). On the other hand, non-price competition is the strategy in which company uses to increase its market share by offering such quality of goods or service, customer focus, or other sustainable competitive benefit other than price. This strategy is such brand management, advertising, or sales promotion (Brue & McConnell, 2002). With the price competition, when one firm lower its price to sell more goods or service, other firms will match the fall in price in order to remain their market share.
If the firms decide to lower prices further, a price war will be happened and it results in firms’ bankruptcy (James & Keith, 2008). “Firms will engage in non-price competition, in spite of the additional costs involved, because it is usually more profitable than selling for a lower price, and avoids the risk of a price war” (Brue & McConnell, 2002). This is the reason why some firms prefer to use non-price competition rather than price competition. Three different ways in which Airlines compete for their market share: ?
Price leadership: This is a type of collusion which Airline industry uses to avoid the uncertainties of competition. This is when one firm has the greatest market share and the firms with lower market shares follow the pricing change prompted by the greatest market share’s firm. This tacit collusion occurs because each firm is likely to minimise a competitive response (James & Keith, 2008). The example of price leadership in the Airline industry is in 1989 American Airlines announced a fare increasing. On the following day, these fares appeared in the Airline Tariff Publishing Company’s computerise database.
Then other Airlines soon followed American Airline by raising the price in a similar amount. Another example is Continental Airlines proposed a price increase; however, some major Airline such as American, Delta did not accept the price change. Then Continental was forced to withdraw its proposed increase if it wanted to remain competitive with the other airline. From these two examples, it shows why the companies need to follow the price set by the leader; it is because they want to avoid uncertainties of competition. ? Gentlemen’s agreements: This is another type of collusion which is the most informal.
Gentlemen’s agreement is unspoken agreement on pricing between competitors based on market behavior (James & Keith, 2008). In this case, price discrimination will be explained; price discrimination means “the product is sold to different buyers at different prices” (James & Keith, 2008, p. 137). For Airline industry, it is known that the Christmas holiday is the high season which all Airlines will raise the price in order to maximise its revenue. For example, between 1 December and 16 January every year which is holiday season, there is the highest number of passengers travelling to oversea; hence, all Airlines will charge the high fare.
Thai Airline raises its price for the destination from New Zealand to Thailand up from $1200 in the normal time to $1600 in the Christmas holiday. Singapore and other Airlines will also do the same way. This is unspoken agreement on pricing between the Airlines industries because they have well understanding on the market behavior. ? The kinked demand curved model: The assumption of the theory is that the companies do not prefer to match price increase but will match a price fall. In the companies point of view, to do this companies can protect and maintain their market shares.
The kinked demand curved model makes a prediction that if the company increases the price but other still remain their price the same, the firm will lose its market share and fall of its total revenue. By contrast, if the company reduce price, other will follow to reduce their price so it is no effect to the market share but the firm revenue will fall (Wikipedia, 2008). Brunei Airline is the good example for this model. Brunei Airline wants to increase its market share in the destination from New Zealand to Thailand so it has to compete with Thai Airline which has the greatest market share in this destination.
Therefore, Brunei Airline decreases its price to $800 in round-trip which compare to $1200 fare from Thai Airline. However, the differentiated products such as non-stop fright, Thai food provided in the Aircraft, and so on make Thai Airline’s market share remain the same. We can see that the first two ways which use non-price competition can help the firms avoiding the unexpected competitors. On the other hand, the third way which uses price competition may create the price war. As we describe above, under perfect competitive, there are a large number of buyers and sellers.
There must be no barrier for both parties to entry into the industry. Graph will be used to make more understanding why a perfect competitive firm is unlikely to make supernormal profit [pic] Figure 1 source from http://www. bized. co. uk/virtual/dc/farming/theory/th12. htm As the graph above, it shows the average revenue (AR1) is higher than the average cost (AC) so it is possible for the individual company to make the supernormal profit in the short- run. [pic]
Figure 2 source from http://www. bized. co. uk/virtual/dc/farming/theory/th12. htm The supernormal profit in the short-run will motivate the new companies into the industry. The more companies are in the industry, the more goods will be supplied. Therefore, the supply line will shift down from S1 to S2 and it results in the lower of price as shown in Figure2. [pic] Figure 3 source from http://www. bized. co. uk/virtual/dc/farming/theory/th12. htm
The fall of revenue curve will continue until the supernormal profit has been away and the firms can just make normal profit as average revenue (AR) is equal to average cost (AC) so it is not motivated new firms into the industry. From the graph above, we can see that, perfect competition can make just normal profit in the long run because there are no barriers for the new competitor to entry into the industry. Therefore, when there are many supplies, the product price will decrease so the firm will make less revenue.
By contrast, the International Airline characterised of Oligopoly which there is just a few large firms in the industry; it means it also has a few number of competitors and it also has barrier to protect new competitor into the industry. However, all Airline industries have there own market share so they want to protect this market share. Therefore, they will try to avoid the price competition in order to avoid price war with can lead them to low profitability and may able to raise bankruptcy. Hence, they will try to work together with non-price competition.
When they use non-price competition, it means they all will get the similar product price. That shows their power to control over the price; so these firms could protect their profit. Hence, it is likely for the International Airline to continue making supernormal profit in wherever the short-run or long-run. Conclusion ? There are four main market structure analysed in this essay which are perfect competition, monopolistic competition, oligopoly, and monopoly and all of them can describe by its own characteristic. Also the Oligopoly is the best description for the Airline industry. There are two different ways of non-price competition that Airline industry uses to protect their market share, which are price leadership, and gentlemen’s agreement. Also the kinked demand curve is price competitive way that company uses to raise its demand. ? A perfect competitive firm is unlikely to make supernormal profit because there are no barriers for new companies to entry into the industry so these new companies can make the price down because of more supply. On the other hand, Airline industries have power to control over the price and there are strong barrier to protect new competitor.
Therefore, they are able to make supernormal profit in the long-run. References Brue. Stanley, L. , & McConnell. Campbell R. (2002). Economics- principal, problem and policies. (15th ed. ). Boston: Irvin/McGraw-Hill. Stewart, J. , & Rankin, K. (2008). Ecomomic concepts and applications (4th ed. ). North Shore: Pearsoned. Wikipedia. (2008). Kinked demand. Retrieved October 26, 2009 from http://en. wikipedia. org/wiki/Kinked_demand Zambia. Perfec competition, Retrived October 26, 2009 from http://www. bized. co. uk/virtual/dc/farming/theory/th12. htm