How contestable is the low-budget airline industry?

I was recently taught about contestable markets and I began to investigate which industries fall into this category. A contestable market exists when there are one or a number of firms which profit maximise. The key aspect of a contestable market is the low barriers to entry or exit, allowing new businesses to easily enter the market and rival existing firms. Contestable markets are both productively and allocatively efficient and are likely to be efficient in the short run as well. A contestable market is common in most industries, even when it seems that there are only a few dominant businesses with significant market power (an oligopoly). A common argument is whether or not the low budget airline industry can be viewed as a contestable market.

A low cost airline is an airline without most of the traditional services provided in the fare, resulting in lower fares but at the same time less comfort. An important aspect of organisations in this industry is to make up for revenue lost in decreased ticket prices, the airline charge for extras such as food, seat allocating, baggage and priority boarding, In recent years there have been several organisations that have dominated the industry like Southwest Airlines, Ryanair and EasyJet. There is evidence to suggest that characteristics of the airline industry reflect that of a contestable market.

Firstly, the freedom to market is high in this industry. It is easy for a new company to enter the market and advertise their flights due to the introduction of websites like Expedia and Skyscanner which advertise all flights travelling to certain destinations and find you the best deals. Websites like these make it easy for new companies to expose their services to potential customers. Users of these websites are able to view all flights without being restricted to only the big name airlines. As a result of this, new companies are able to rival existing firms by price penetrating (setting prices at the lowest price possible) to attract their target market. This freedom to market shows us how there are little barriers to entry for firms in the low budget airline industry.

On the other hand, it can be argued that this industry is actually a non-contestable market due to the high sunk costs. These are costs that once you pay for, you can’t get back. To get into the industry, the company will have to invest millions into acquiring licenses and following safety measures to be allowed to provide their services for customers. These are costs that you can’t get back so therefore this can be considered as a high barrier to entry, which are typically not there in a contestable market. Additionally, (although minimal in the low budget airline industry), there can be strong brand loyalty for some airline, especially those that offer airmiles to returning customers. This means new firms will have to invest a lot into a advertising, a sunk cost that is non-recoverable. This makes the market less contestable. However, for many customers, brand loyalty is not existent in the low budget airline industry due to more focus on getting cheap prices.

Furthermore, the UK low budget airline industry can be seen as a contestable market ever since the deregulation of the industry between 1987 and 1997, where air transport within the EU was deregulated. With deregulation, subsidies that were previously given to national carriers were removed, allowing fair competition between European carriers. This allows new companies to easily enter the market and compete with existing firms. The UK low budget airline industry is growing and becoming more competitive due to an increasing demand, which is beneficial to new companies as an increase in the number of consumers using flights means there can be an increase in the number of firms providing these services.

I am convinced that the low budget airline industry is a fairly contestable market due to the ease at which new firms can attract new customers through existing flight websites and the theory of perfect knowledge where all firms have access to the best technology. However, there are still barriers to entry and exit present like high initial sunk costs that can result in a loss for new firms. For this reason, it is not perfectly contestable.

Can fear define an economy?

Behavioural economics is an aspect of economics, where elements of psychology are added to traditional mathematical models in order to better understand decision-making. I have become fascinated by these studies and have recently read many books regarding different behavioural economic researches. Economics is a study of understanding the choices individuals within an industry make and I believe taking into account emotions is a pivotal aspect in making economic predictions.

Lets look into the issue of fear within economics. It can’t be denied that the fear of future global events and economic history influence economic decision-making. A main cause of fear within an economy is uncertainty as handling large sums of money is not made easier when events occurring in the global economy make it hard to predict what will happen. That is one of the main concerns of Brexit, the uncertainty.

Hysteresis is an idea that can show the impact of fear on consumer behaviour. Hysteresis is when people are influenced by events in the past. Even if circumstances are different in the present and there is strong evidence of improvements from past events, this still remains a strong influencing point within people making economic decisions. One study I did which seemed to support this theory is the fluctuation of demand for inferior goods within an economy.

An inferior good is a good a consumer would demand less off if their income level increased. Examples of companies that operate for the sale of inferior goods are Primark and Poundland. Traditionally, companies selling inferior goods would see an increase in sales during times of recession and a fall in demand during strong periods of economic activity. However, recent research I did into businesses that fall under this category suggested signs of continued growth even during this period of recovery since the 2008 recession.

Companies like Primark and Sports Direct have continued to see exponential growth post the recession, which contradicts past trends. I believe the theory of hysteresis can be argued as a cause of this. Consumers who may have lost money during the 2008 recession may be incentivised to spend their money more carefully and purchase goods from these companies in fear of another recession occurring.

The issue of fear is a very real problem in economics and it is one that must be taken into account when studying economic trends. It’s important to view things from a consumer’s view, who may have inadequate information about things occurring in their economy (inflation rates, economy growth rates etc). When fear influences an individual’s decisions, it can contradict any mathematical model that has solely been formulated off past trends, essentially altering the way we have been looking at an aspect of economics.