Question

All four leading U.S. airlines - American Airlines, Delta, United, and Southwest- are down about 10 percent from their respective highs set two weeks ago. The fall came after Southwest Airline's decision to increase fleet capacity 7 percent and American Airline's response that they will "compete aggressively" on price to retain customers from low-cost carriers resulting from capacity increases. Source: www.seekingalpha.com, June 1,2015 As implied in the news clip, what type of market best describes the U.S. airline industry?

Short answer

The U.S. airline industry is best described as an oligopoly.

Step-by-step solution

Identify the Market Characteristics

List the characteristics of different market structures: Perfect Competition, Monopolistic Competition, Oligopoly, and Monopoly. Determine which characteristics apply to the U.S. airline industry.

Assess Market Players

Note that the U.S. airline industry is dominated by a few major airlines: American Airlines, Delta, United, and Southwest. This indicates a limited number of players, characteristic of an oligopoly.

Examine Price Competition

The news clip mentions aggressive price competition. In an oligopoly, firms often compete vigorously on price, as seen with American Airlines' strategy to compete on price.

Analyze Strategic Behavior

Southwest's decision to increase fleet capacity and American Airlines' aggressive price response indicate strategic behavior, common in oligopolistic markets where firms' decisions are interdependent.

Conclude Market Structure

Given the limited number of major players, price competition, and strategic behavior in responding to competitors' actions, the U.S. airline industry is best described as an oligopoly.

Key concepts

Oligopoly

The U.S. airline industry is a classic example of an oligopoly. An oligopoly is a market structure where a small number of firms dominate the market. In the case of the U.S. airline industry, the dominant players are American Airlines, Delta, United, and Southwest. These airlines control a significant portion of the market share, making it difficult for new entrants to compete effectively.
In an oligopoly, firms are highly interdependent. This means that the actions of one company can significantly impact the others. For instance, if one airline lowers its prices, others may feel compelled to do the same to stay competitive. This interconnectedness is a hallmark of oligopolistic markets.
Another characteristic of oligopolies is the potential for collusion, where firms might work together to set prices or output levels to maximize profits. However, in many countries, including the U.S., such practices are illegal antitrust violations.
Understanding that the airline industry operates as an oligopoly helps explain the competitive behaviors and strategic decisions made by these major airlines.

Price Competition

In an oligopolistic market like the U.S. airline industry, price competition is a key feature. Price competition involves airlines adjusting their pricing strategies in a bid to attract more customers and increase market share.
The news clip mentions American Airlines' intention to 'compete aggressively' on price, highlighting how price wars can be a common occurrence in such markets. When one airline reduces its fares, others may follow to avoid losing customers.
Price competition can lead to lower airfares for consumers in the short term. However, it can also put pressure on airlines' profit margins. Constantly lowering prices might not be sustainable long-term if it leads to minimal or negative profits.
This behavior is indicative of the airlines’ struggle to balance between maintaining competitive pricing and ensuring profitability. Understanding price competition helps grasp why major airlines might quickly alter their pricing strategies in response to competitors.

Strategic Behavior

Strategic behavior is another core concept in oligopolistic markets such as the U.S. airline industry. In such markets, firms do not make decisions in isolation; they must anticipate and react to the moves of their competitors.
The decision by Southwest Airlines to increase its fleet capacity by 7 percent is a strategic move aimed at increasing its market presence and capacity. American Airlines' response to compete aggressively on price is a counter-strategy meant to retain its customer base.
These actions reflect the strategic behavior where each airline must consider the potential reactions of its rivals before implementing new strategies. This interdependence often results in a series of competitive and retaliatory actions that shape the market dynamics.
By examining such strategic behaviors, one can better understand the complex interactions between major airline players and how these interactions influence overall market trends.

Market Characteristics

The U.S. airline industry exhibits specific market characteristics that distinguish it as an oligopoly. Key characteristics include:

• Few Major Players: There are a limited number of dominant airlines, such as American Airlines, Delta, United, and Southwest. These few firms hold significant market power.
• High Entry Barriers: Entering the airline industry requires substantial capital investments in aircraft and infrastructure, keeping potential competitors at bay.
• Interdependent Decisions: Airlines are acutely aware of their competitors' actions. Decisions on pricing, routes, and capacity are often influenced by anticipated or observed actions of other airlines.
• Non-Price Competition: Besides competing on price, airlines often compete through other means like improving customer service, offering more flight routes, and investing in fleet upgrades.

These characteristics help explain why the U.S. airline industry remains dominated by a few key players and exhibits behaviors typical of oligopolistic markets. Understanding these traits is crucial for anyone studying market structures and competitive dynamics within the airline industry.