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.

Is economic growth bad?

To most people, the achievement of economic growth would be seen as a complete success for an economy in any circumstance.  Economic growth is measured by the increase in a country’s total output or real GDP compared from one period of time to another. The UK’s GDP growth rate has fluctuated over recent years, with the economy being in one of the slowest recovery stages. Yes, economic growth can have many benefits for the UK economy, but it can be argued that unsustained growth can be more damaging to the economy than beneficial.

One of the main aims for the UK government is to lower unemployment. When there is economic growth caused by an increase in aggregate demand, firms are incentivised to create more job opportunities. This is because there will be an increase in demand for labour, as firms will want to produce more in order to capitalise on higher demand. This therefore lowers unemployment. Lower unemployment reduces the strain on the government and taxpayers to support a population of unemployed people. Furthermore, with more people in the labour force, there is more people for the UK government to receive income tax. This is beneficial because the government can use this increased revenue to reduce the level of government borrowing and spend more on public services and investment in the country’s infrastructure.

This investment in public services can help improve the long-term performance of the economy. For example, better infrastructure enables lower cost of trade. However, this can have negative externalities in the form of third party costs caused by pollution and resource depletion. Future generations will not able to function in the same way if resources are lost so it can be argued that if the economic growth is not controlled, it can be unsustainable.

Another problem caused by economic growth driven by a rise in aggregate demand can have negative effects on inflation, potentially causing it to go above the MPC’s target rate of 2%. The AS/AD graph below shows us how an an increase in aggregate demand (an outward shift) would result in the price level (inflation).

The Phillips Curve also shows us how if unemployment is low, there will be high rates of inflation. On the other hand, if the economic growth is caused by improvements in the supply side of the economy, inflation may be actually be reduced in the long term.  However, it can be argued that this increase in economic growth can have negative effects on the current account deficit as it can lead to a rise in the value of the pound and result in a rise in the import rate, as there will be a high marginal propensity to import in the UK. With economic growth, the pound value increases, as there will be more business opportunities in the UK, therefore increasing the demand for the pound, increasing its value. A stronger pound causes exports to become more expensive for foreign countries, which will negatively affect the balance of trade.

In contrast to this, if the economic growth is driven by an expansion in the sales of domestic goods and services in other countries, it may not be a problem. This will generate a flow of money for the UK from abroad, which can be used to strengthen the domestic economy and raise living standards. However, this is a risky strategy as there is high dependence on foreign markets and can be faltered by a recession in foreign countries, which is out of the UK government’s hands. It also depends upon foreign demand and whether producers in the UK can produce goods that will make high sales in other countries, taking into account import taxes.

The consequences of economic growth highly depend upon the causes of it: whether it is aggregate demand driven or aggregate supply driven. Economic growth is obviously better than an economic decline but only if it is controlled to prevent negative externalities.