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Airline Industry and Contestability Project - What is a contestable market?

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Introduction

Airline Industry and Contestability Project What is a contestable market? In a contestable market, there are one or a number of firms which profit maximise. In other words the number of firms is irrelevant. The key assumption to make here is that barriers to entry to the industry are relatively low, as is the cost to exit the industry. The existence of potential entrants into the industry will tend to keep profits to their normal level even in the short run, because existing firms will want to deter new entrants from coming into the market. Contestable markets are both productively and allocatively efficient and are likely to be efficient in the short run as well. The theory regarding the type of profit made in a contestable market is this. Abnormal profit can only be made in the short run, only normal profit will be made in the long run. The reason being is that when firm try to profit maximises in the short run then this will attract new entrants into the market to take some of this profit away from the existing firm. As more competition is attracted then the new prices will force the prices and the profit down. ...read more.

Middle

As the population of Europe has more disposable income the demand for short haul flight from city to city has increased. This provides an opportunity for low cost airlines to enter the industry and compete with the major airliners. As there is price sensitivity in the airliner market, it is naturally suited to low cost airlines, as customers will choose them instead of another. An act called "freedom of the air" means that an airline holding a valid Air Operations Certificate in the EU can't be prevented from operating on any route within the European Union, including flights wholly within another country. Granting these freedom rights makes the market more contestable, because any airline with a valid license can fly passengers. Airlines enjoy substantial tax exemptions, particularly from all taxes on kerosene. This exemption for kerosene applies to international and intra-EU flights alike. This tax exemption for fuel provides no incentive for airlines to use the most efficient aircraft and to contribute to reducing CO2 emissions (of which air transport accounts for 13%). It also creates situations where the competition between air transport and other modes is unfair. This exemption makes the market more contestable as airliners have no pressure to keep pollution low, so if more airliners enter the market complaints of more pollution can be ignored. ...read more.

Conclusion

Another reason why it may be less contestable is that they have received many customer complaints for quality of service. In a less contestable market firms are under less pressure to produce a service of the highest quality. Recent mergers involving Easyjet and Ryanair have meant that the industry is being dominated by two big firms. This is an example of a Contestable market, because there is less competition and these larger firms will benefit from economies of scale such as brand loyalty and these firms will have more slots for taking off or landing, which reduces the amount of competitors that can enter. The reason why it may be contestable is that in the industry there are lots of profits to be made. An increase in Ryanair profits would attract "hit and run" competition. Another reason is that Ryanair was able to purchase a Boeing 747 at a significant discount. This means that there will be low sunk costs as these planes could be sold off if you decide to exit the industry. To conclude it can be said that the low cost airline industry is seen as contestable, because of the east to set up, excess profits, but recent news show that it is more becoming less and less contestable with mergers and few firms producing at low cost and really dominating the industry. Airline Industry and Contestability Imran Hans 1 ...read more.

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