Microeconomics Over the Last Few Years it Essay

Excerpt from Essay :

Microeconomics

Over the last few years, it is evident that the airline industry in the U.S. has been experiencing long standing as well as novel challenges (The American Antitrust Institute, 2012). These includes the increase in the price of fuel, slowing demand for air travel and pressures to expand globally. Consolidation among various airlines across the country is the most common remedy that most of the airline firms are applying.

In April 2012, the U.S. Airways made an announcement to move and take over the American Airlines. American airline is the fourth largest airline in the United States while U.S. Airways is the fifth (Plane Buzz, 2013). This merger, therefore, will make the U.S. Airways- American the largest in the United States with a combined share of more than 21% (The American Antitrust Institute, 2012).

The merger is worth 11 billion U.S. dollars and will turn America into the largest airline in the world (Anonymous, 2013). This merge might present a conundrum for the antitrust authorities in U.S.A. One of the chief challenges as a result of this merger will be fend off the prevailing argument that this merger cannot harm competition as well as consumers. This is because American Airlines is currently in bankruptcy proceedings and, hence there is a likelihood of failing and exiting market. Another challenge as a result of this merger is the claim that it would compete with the two existing legacy, Delta and the United Continental (The American Antitrust Institute, 2012).

There are potential consequences as a result of merging. The merging will also result to change in market structure of the airline industry in the United States. In addition, while the firms will be aiming at profit maximization, there will be significant impacts on both the customers as well as the firms themselves.

Potential Consequences of Merging

Bearing in mind that the number of legacy carriers in the United States will be down to only two, it is a fact that the proposed merger might alter the landscape of the airline industry in the country, in some expected as well as novel ways (The American Antitrust Institute, 2012). For instance, it is evident that there is possible domination of market by the merger carrier. Consequently, others would display the various features of oligopoly that is few independent firms.

The proposed merger might also be the capstone event, which transforms the airline industry into a significantly different one from what people know (The American Antitrust Institute, 2012). With regard to antitrust as well as aviation policies, it is clear that there is encouragement of the formation of fortress hubs, which are making a new entry at hub airports difficult. In addition, the entry which does not occur has a high possibility of providing a weak, as well as ineffective competition. Also, other airports in major cities across the United States do not exist in large numbers for the purpose of rescuing all the consumers affected adversely by the previous mergers (Lee, 2013. The most important part of this is that the majority of the secondary airport in the country are now becoming dominated by biggest of the former LCCs . This results to a drastic change of the airline industry in the country in which hubs should be open facilities. This is where the competing airlines provide service only to few enormous and closed systems which are impermeable to stiff competition.

According to transportation experts, the merger is likely to create more flights as well as opportunities for customers of both airlines, with each of the airline providing complementary services to the travelers. This situation is beneficial to the merger as the loss Delta in 2011, led to the creation of situation where the airport is currently reliant to the U.S. Airways (The American Antitrust Institute, 2012).

Change in Market Structure

Market structure is the number of firms in a certain industry that produces identical products, or offer identical services that are homogenous (Economic Theory, 2000). There are four types of market structure; these include monopolistic competition, oligopoly, monopoly and perfect competition (Economic Theory, 2000). With regard to the merging of U.S. Airways and American Airlines, it is true that this will result to a change in the market structure from monopolistic competition to oligopoly. Currently the market structure in the airline industry in the United States is monopolistic competition. This is because there are several firms in the industry each having a significant proportion of the market share as well as slightly differentiated services (Economic Theory, 2000).

After the proposed merger, it is true that the number of firms in the industry will reduce leading to the formation of oligopoly. This is a type of market structure where the industry has a relatively smaller number of firms in the market. A general lack of stiff competition in the oligopoly market structure, usually leads to higher costs of services for consumers (Economic Theory, 2000). Due to the fact that there are few big firms in the industry, each firm in the market is always aware of the actions of other firms. The decisions of one firm usually have significant impacts on the decision of the other firms in the industry (Economic Theory, 2000). Similarly, this is likely to happen after the implementation of the proposed merger. Few large firms in the U.S. airline industry will dominate the market and each firm will be dependent on the actions of the other firms in the industry. When this happens, strategic planning by each firm needs to take into proper consideration the possible responses of the other participants in the market.

Profit Maximization

The proposed merger aims at maximizing profits. This is because the result of merging is that there will be an increase in fees by at least five percent. The post-merger prices are likely to increase due to various reasons (Raper, Love & Shumway, 2007). First, based on analysis, it is evident that there is an enormous number of significant pre-to post merger increase on charges on the hub to the hub overlap routes affected by the United Continental, as well as Delta Northwest mergers (The American Antitrust Institute, 2012).

Putting the above into consideration, it is a fact that the fare increases usually reflect the exercises of the market power enhanced by the merger (Plane Buzz, 2013). In addition, fare increases also reflect the fact that before the merger, the two merging airlines were each other's greatest rival. This implies that a fare increase by one airline could lead to significant sales to the merging partner, leading to the creation of upward pricing pressure, as well as increases in probability of increase in post merger prices (The American Antitrust Institute, 2012).

Irrespective of the underlying theory, increase in fare might reveal how the merged carrier will dominate at the hubs, which serve as origination as well as a destination for routes over which the merger can exercise market power (The American Antitrust Institute, 2012). With regard to this, it is evident that the result of the merger will lead to profit maximization, which will in turn result to the development of the mergers in the near future (The American Antitrust Institute, 2012). The diagram below illustrates how the merger will maximize profit.

After the two carriers merge, they will try to fix the price at the level that maximizes profits for the industry.

Since the merger of the two firms will result to change in market structure to oligopoly, the firms will maximize profits where the marginal revenue will be equal to marginal costs. This idea can be illustrated graphically through intersection of a downward-sloping marginal revenue curve with an upward-sloping curve of marginal curve.

The motivation behind the kink is the idea that firms in oligopoly will not raise their prices as even a slight increase will lead to loss of many customers. This will happen after the two firms merge.

Impact on Travelers and Firms

The implementation of the proposed merger will have several impacts on both the travelers and the firms (Plane Buzz, 2013). Considering that the merger will remove one firm from the already consolidated market in the United States, air travelers will expect a significant rise in air tickets. In addition, this will be as a result of decreases in competition in the airline industry. Current research indicates that the price of the air tickets will rise significantly with between five and ten percent once the two airlines merges. The result of this on the two airlines is that it will lead to the realization of more profits leading to development. This is because the merger will be able to maximize profits while minimizing costs (Plane Buzz, 2013).

Another possible impact of the merger is that, although nothing much will change in the short-term, there is a high possibility that travelers will wait longer in the reservations lines. In addition, there will be more computer glitches as well as scheduling problems as the two airlines start to…

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