South-Western College Publishing - Economics  
Airline Amalgamations
Subject Barriers to entry and comparisons with competition
Topic Monopoly
Key Words Takeover, service, merger, deregulation, consolidation, fares, prices, competitors, markets
News Story

United Airlines has proposed to purchase US Airways for $4.3 billion. The deal would create an airline that would carry one-fourth of all airline passengers in the U.S. The airlines assert that the takeover will actually improve customer service. They believe that they would be able to provide more routes in the East and seamless international service. This plan has already provoked merger talks between the other airlines.

Consumers and Congressional members are not so sure that service would improve. Since 1978, when the airlines were deregulated, there has been a significant consolidation of airlines. Many travelers now experience high airfares, long check-in lines, uncomfortable journeys, delays, and tasteless meals (if any). Studies demonstrate that fares are higher at hubs dominated by few carriers. Some airlines have been accused of illegally driving small competitors out of some markets. Customer complaints are rising, and have prompted airlines to issue voluntary standards. There is a fear that fewer airlines will mean less competition for the passenger's dollar, and that prices will increase even more.

United is trying to dampen criticism. It promises not to raise fares for two years unless its costs, especially fuel costs, increase. US Airways says it will sell its operations at Reagan National Airport in Washington, D.C. to DC Air so as not to dominate the area. However, this may be a ploy to keep the gates out of the hands of its major rivals, and DC Air would still rely on United for all services from ticketing to maintenance.

(Updated August 1, 2000)

Questions
1. a) How would the takeover of US Airways by United Airlines affect the amount of competition at airports?
  b) How would it affect the demand curve for seats on United at airports where US Airways and United were the only former competitors?
  c) Draw a price-output diagram of United's demand and marginal revenue curves and its average total and marginal cost curves before and after the takeover (if it is approved). What would happen to the former and the prospective equilibrium price and quantity if the takeover were approved?
2. Appraise the arguments regarding the likely changes in customer service following the merger. Specifically,
  a) Are the airlines' arguments plausible? Explain using economic theory.
  b) Are the fears of consumers and politicians firmly grounded? Answer with reference to economic theory.
3. a) Explain why the possession of gates at airports is a barrier to entry that lessens competition.
  b) Why does US Airways' proposal to give gates to DC Air fail to reduce barriers to entry?
Source Laurence Zuckerman, "A New Math: Fewer Airlines + Higher Profits = More Competition," The New York Times, June 22, 2000.

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