To address this question, we must first consider what type of
competition the airline faces on its route. If it is truly a
monopoly, then it is "...a single seller with complete control over an
industry.... It is the only one producing in its industry, and there
is no industry producing a close substitute," (page 164). A
monopolist seeking to maximize its profits will seek to sell the
equilibrium price and quantity of a product or service that yield the
largest profit. "An important result is that maximum profit will
occur when output is at that level where the firm's marginal revenue
is equal to its marginal cost," (page 172).
However, does an airline with a monopoly route really have a monopoly?
In most cases, probably not. Competitors exist in the form of
alternative modes of transportation and airlines with competing
routes. People can choose to travel by car, train, or boat between
the two locations served by the monopoly route, depending upon
situation. People can also opt to combine modes of transportation,
allowing them to drive to a different airport to fly to their ultimate
destination or to fly to a different airport and then drive to their
ultimate destination. As a result, it appears that the airline can be
more accurately described to be engaged in monopolistic competition
with a large number of sellers producing differentiated products
rather than to be in possession of a true monopoly.
The extent of the competition will determine the airline's attitude
and obligations in setting its pricing policy for its monopoly route.
If consumers have relatively few options, quantity and price "...will
reach an equilibrium that lies between the high-price monopoly
equilibrium and the low-price equilibrium of perfect competition,"
(page 185). As the number of options available to consumers
increases, "... industry price and quantity tend toward the output of
the perfectly competitive market," (page 185). However, "in many
situations, there is no stable equilibrium for oligopoly. Strategic
interplay may lead to unstable outcomes as firms threaten, bluff,
start price wars, capitulate to stronger firms, punish weak opponents,
signal their intentions, or simply exit from the market," (page 185).
The airline industry in the United States certainly exhibits the
characteristics of a marketplace lacking a stable equilibrium.
Even if the airline has a strong, near-monopoly position, if it fails
to reasonably satisfy demand by providing adequate quantities at
acceptable prices, its market position is likely to erode. The
airline does not have a monopoly on airplanes and landing slots at the
airports served by its route. As a result, if it is unusually
profitable, additional airlines will acquire their own planes and
landing slots and seek to serve its route, resulting in a decline in
the original airline's market share. Over time, in the case of
monopolistic competition, "...prices are above marginal costs but
economic profits have been driven down to zero," (page 183) meaning no
one desires to enter or is forced to leave the industry.
Monopolies are also understood to cause economic waste by restricting
output. Monopolists sometimes are tempted to provide poor quality
products and/or services when consumers have few alternatives if doing
so will increase profits. Monopolists are also viewed in popular
culture as enriching themselves at the expense of helpless consumers.
If the airline engages in any of these practices excessively, it may
be viewed as violating its obligations to its customers. Consumers
may take a variety of actions that can be harmful to the airline,
including encouraging competitors to enter the market, utilizing other
modes of transportation, and seeking to disrupt the airline's
operations through protests.
Consumers may also demand government intervention to address the
perceived abuses. Government intervention can take many forms,
including imposing taxes to reduce monopoly profits, imposing price
controls to limit prices in concentrated industries, and even
nationalizing monopolies. Less extreme tools include regulation to
oversee prices, outputs, entry, and exit of firms in regulated
industries, antitrust policy, and promoting vigorous competition.
As a result of these factors, while the airline with a monopoly route
obviously would prefer to provide the number of flights at the price
that results in its marginal revenue being equal to its marginal cost
so that it maximizes profits, many factors make this outcome unlikely.
The presence of the unusual monopoly profits will attract new
competitors to enter its market unless extraordinary barriers to entry
exist. Consumers who are not being served will gravitate towards
alternatives, which decreases demand for the airline's services and
forces it to reduce prices. Furthermore, pricing policies that are
perceived to abuse consumers and not meet the airline's obligations to
provide a useful public service invite government intervention, which
could be very detrimental to the airline's profits. Therefore, while
the airline will certainly price its service so that it is profitable,
it must consider the availability of alternatives to its customers,
barriers to entry facing potential competitors, and the likelihood of
government intervention before it pursues a pricing policy that seeks
extraordinary profits.
Sincerely,
Wonko
Reference: Economics, 14th edition, Samuelson & Nordhaus, McGraw-Hill Inc., 1992 |
Clarification of Answer by
wonko-ga
on
20 May 2004 08:42 PDT
My answer is country independent. In the case of the United States,
the airline industry was heavily regulated from 1938 to 1978, and no
new air carriers were allowed to enter the interstate market. In the
absence of competition, fares were high. In 1978, the industry was
deregulated and airlines were allowed to compete on price and service.
The government was successful in promoting vigorous competition
between airlines, resulting in many new airlines, many bankruptcies,
and a marked decrease in average fares. So, given that airlines can
freely enter and exit all domestic air routes in the United States,
our airline with a monopoly route must consider the risk of attracting
competitors before it sets its fares well above its costs.
In order to succeed, the airline must satisfy its stakeholders.
First, it must provide its shareholders with a return on their
investment. While clearly the airline would like to maximize profits,
it will be unsuccessful if it attempts to do so in a manner that
significantly adversely affects its other stakeholders: its employees
and the traveling public. If wages are too low or fares are too high,
the airline may face work stoppages, a loss of customers, and/or
government regulation. Any of these outcomes hurt profits.
Therefore, the airline must balance the interests of its stakeholders
when establishing its pricing policy.
Sincerely,
Wonko
|
