When planning a vacation abroad, the first mode of transportation that people think of is airplanes. Unfortunately for us, they don’t come cheap. According to the US department of transportation, the average price for a domestic flight was $378. When flying with many big airlines such as American Airlines, Delta, Southwest and United, one might notice similar pricing of their plane tickets. This is no small coincidence; these airlines are suspected of colluding to force consumers to pay high prices. But how come nothing is done to stop this?
The Airline Industry Market Structure
Some suspect that these major airlines operate in an informal collusive oligopoly. An oligopoly is a market structure where a small number of firms make similar or identical goods or services and have a decent amount of market power in the industry. One that is informally collusive implies that these small firms make implicit agreements to limit competition. Normally among the group, there is a price leader (in this case, it is Southwest). This means that when Southwest changes this price, other airlines change their prices accordingly. This creates high barriers to entry.
Why are prices the same?
Airline prices tend to stay the same to avoid price wars through price competition among each other in order for all firms involved to be better off. This is best explained through the prisoner’s dilemma, a common example of game theory.
Prisoner’s dilemma
(revenue in millions)
Consider the figure above. Each firm has two options that greatly affect the other firm: to sell at a high or low price. The goal of every firm is to make the most revenue and will take the respective action to do so. For example, if airline 1 chooses to sell their tickets at a high price, airline 2 will sell their tickets at a lower price to make the most revenue. Likewise, if airline 1 chooses to sell their tickets at a low price, airline 2 will also lower prices. So, regardless of the actions of airline 1’s actions, airline 2 will always lower their prices. By the same logic, regardless of airline 2’s actions, airline 1 will always lower their prices as well. Thus, at the end of the day, both airlines will make 20 million dollars each (also known as their nash equilibrium). But, this is not the best outcome for both firms because if they decided to collude and both charge high prices, they would have been making 50 million each. So, through price competition, both airlines are worse off. This leads airlines to avoid price competition to prevent loss revenue.Â
Instead, these airlines choose to compete via non-price competition in the forms like advertisements, incentives and branding. For example, Delta offers its passengers SkyMiles for choosing to fly with them. This allows these big firms to compete with one another without causing major consequences to each other.
This causes market failure as the airlines are abusing their market power to control their revenues and force out other smaller airlines.
Will this end?
The likelihood of this trend ending is unlikely because of the difficulty to prove if firms are colluding to limit competition in the industry. Because multiple firms are engaging in unfair practices, it is hard for the government to name any perpetrators as there are no written agreements to collusion. Furthermore, it is hard to pinpoint which firms are participating in this behavior, as other firms besides these major four could be colluding as well. This makes it virtually impossible to end this behavior.Â
This type of oligopoly, however, may not last. Because there is no written agreement stating they must keep their prices the same as their counterparts, an airline may decide to cheat and lower their prices to gain more revenue. This may cause the oligoploy to collapse.Â
The airlines may eventually dispute the price at which they set their tickets due to their different prices of production. If the price is set below or near the cost of production of an airline, the airline will reject this price. This may lead to conflict within the colluding parities which may result in the collapse of the informal collusive oligopoly.
For the time-being however, consumers looking to travel with these big airlines may need to pay high prices.