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An Analysis of Oligopoly in US Airline Industry

BY: Vivek SHARMA | Category: Finance | Submitted: 2011-02-26 06:51:51
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Article Summary: "The article attempts to explain Oligopoly in US markets.It explain under which model of oligopoly airlines operate under i.e. Sweezy model, Cournot model, Stackelberg model or Bertrand model. If they do not operate under any of these, what is the reason for the same?.."


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Oligopoly is form of market characterized by presence of few sellers who maximize their profits by producing to the extent of making marginal cost equal to marginal revenue. Following are the features of oligopoly:

1) In oligopoly, suppliers operate with profit maximization objectives.

2) There are able to set prices.

3) There are high entry and exit barriers in terms of economies of operations, usage of high end technology etc.

4) There is product differentiation in the market.

5) There is interdependence among firms.

An example of real life industry operating under oligopoly is,' Airlines Industry'. The below mentioned data related to US Airlines companies gives an insight into the fact that airline companies operate under oligopoly:


Airline Domestic Market Share November 2009- October 2010
--------------------------------------------------------------------
Airlines | Market Share (%)
Delta : 15.8
Southwest : 14.0
American : 13.7
United : 10.2
US Airways : 7.9
Continental : 7.4
Data Source: www.transtats.bts.gov


The above mentioned six airlines have more than 70% of the market shares in domestic airlines in USA. The domestic airlines industry in US meets most of the features of an oligopoly market.

The airlines industry in US does not operate under any of the four models i.e. Sweezy model, Cournot model, Stackelberg model or Bertrand model. The explanation for this is as follows:

1) Sweezy Model: One of the key assumptions of Sweezy model is that firms operating under this model react to price cuts by rival firms while they do not respond to increase in the price by rival firms. This is not the case in US airlines industry as there is product differentiation in the airlines market. This results into price differentiation logically. The price differentiation on a Boston to New York route can be as high as the information given below:

Airfare :Boston to New York ( Mar, 2011 fare)
---------------------------------------------------
Name of Airlines | Air Fare
Delta : $55
US Airways : $169
United : $179
Continental : $448
Source: www.orbitz.com

Since the price charged by airlines companies is different, the rival firms don't react to price cuts which are one of the key assumptions of Sweezy model.

2) Cournot Model : Under this model, the firms operate based on the expectation that its own output decision will not have an effect on the decisions of its rivals. Though there is a price differentiation in US airlines industry but price sensitiveness also prevails. Low cost airlines keep a watch on pricing of rival firms and accordingly decrease or increase price. Hence, the firm is not able to decide its own output levels which is essentially influenced by the actions of rival firms

3) Stackelberg Model: Under this model leader firm move first and then other firms move sequentially. This is not the case as firms try to outperform each other in airlines business by designing new strategies. There are different segments within the industry and hence there is no significant impact of movement by leader firm.


4) Bertrand Model : US Airlines industry does not fit into Bertrand model as well, because as per the model firms compete by setting the prices simultaneously and the consumers buy the product from the firms who sell it cheapest. If this was the case, there won't be so much of price differentiation which is case in the example above ( See airfare Boston to New York, example)

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