The Airline Case: Is Bigger Better?

The Airline Case: Is Bigger Better?

From Focus: High School Economics, © National Council for Economic Education, New York, NY

Imagine that is 10 years from now and you have been hired as a consulting economist for the Antitrust Division of the Department of Justice. The following case is given to you for review. Use what you know about markets plus the information in the case to suggest a policy to the assistant attorney general in charge of antitrust actions.

Two relatively new airline companies, Gigantic Airways and Nationwide Airlines, have announced plans to merge. The leading airline companies and their respective shares of total US ticket sales over the past year are:

United / 17%
American / 15%
Delta / 14%
Gigantic / 11%
Northwest / 10%
Nationwide / 9%
Southwest / 8%
All others / 16%

During the past five years, the airline industry has become more concentrated as smaller airlines have gone out of business or merged with larger companies. Note that the four largest airlines now account for 57 percent of total sales.

Arguments against the merger: Some staff attorneys at the Justice Department believe the merger should be opposed. They believe the merger of the fourth and sixth largest airlines will continue what they regard as an unhealthy trend toward larger airlines, a higher concentration of sales, and less competition. The newly merged airline will be the largest in the nation, with more sales than the leading firm now has. Aggressive advertising campaigns by the large airlines are raising significant barriers to the entry of potential new competitors.

Arguments for the merger: Attorneys for the companies involved have filed papers arguing that the merger would not materially affect competition in the industry. Most of Gigantic Airway’s business consists of coast-to-coast flights using very large aircraft. Nationwide Airlines specializes in shorter flights using smaller planes and the hub concept. Only four cities are now served by both airlines. Furthermore, the attorneys argue that neither airline can survive in the long run without the merger, because of heavy competition from the largest firms in the industry today. The merged company would have a larger advertising budget and could realize substantial economies in their reservation and ticket sales operations. The company attorneys state that if either of these two companies fail, the lost sales will go primarily to the largest three airlines, and thus increase concentration in the market even more. The attorneys argue that one strong competitor is better than two smaller companies going out of business.

Question: Should the Justice Department announce that it will oppose the merger? What is your recommendation? Explain your position.

_____Support the merger.

_____ Oppose the merger.

Why?