To what extent is the UK airline industry a contestable market?

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UK AIRLINE INDUSTRY

To what extent is the UK airline industry a contestable market?

The UK airline industry is seen as a contestable market ever since after the deregulation of the industry between 1987 and 1997 where air transport within European Union was deregulated. With deregulation, subsidies that were previously given to national carriers were removed, allowing fair and free competition between European carriers. The UK airline industry was already independent by state subsidies since the privatisation of British Airways in 1987.  

We can see that UK airline industry is growing and becoming more competitive due to an increasing demand. The percentage of UK household income that is spent on holiday also rises as they have a higher standard of living compared to 20 years ago. Nowadays, there are plenty of options of flights with a range of prices and we can buy an airline ticket through the internet. Passengers are expected to benefit from lower fares, higher flight frequency and more routes.

It is important for the UK government to implement strict policy to make sure the airline companies are running the industry in the general interests of the public. It has been stated that the aviation industry directly provides jobs for over 180,000 people in the UK which contributes £10.2 billion to UK gross domestic product. Therefore, airline industry in the UK plays a significant part in the economy.

First of all, we need to identify the characteristics and the nature of an ordinary contestable market and how it differs with other types such as perfect competition or monopoly. In a contestable market, government control and regulation are minimal, so basically the market determines the price. There are no sunk costs in order to enter a contestable market, which means that a firm can enter or leave the market without any cost. This implies that there may be no cost discrimination against entrants in favour of incumbents. If a contestable market only consists of few large firms, the costs differences among the companies are only from the distinction of price and quality, thus the number and size of firms are irrelevant. However firms have to keep their price competitive in fear of potential entrants and existing competitors.

Supernormal profits cannot be earned in the long run. As there is no cost to enter and leave the market, a new firm can take advantage of this in a ‘hit and run’ basis where it enters and gain supernormal profit in a short run and then leave at no cost. The threat of such competition forces monopolists and oligopolists to offer consumers the benefits that they would receive in a more competitive market structure. Firms in a contestable market expected to be productive and allocative efficient. They produce where the average cost is at its minimum and also where price equals to marginal cost. A source

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Cross-subsidization does not occur since a firm earning only normal profits cannot afford to sell any of its products at low prices that do not cover its cost. Predatory pricing is therefore abolished as a weapon of unfair competition. Economists argued that predatory pricing does not even bring profit for the firm in the long run. The UK government face a problem of distinguishing it from ‘innocent competition moreover after the introduction of ‘no-frills’ airlines where the they can afford to put up a lower price due to low operating cost. The existence of these no-frills airlines will be ...

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