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Australian Airline Oligopoly Essay

2760 words - 11 pages

Topic A (oligopoly)

An oligopoly is defined as "a market structure in which only a few sellers offer similar or identical products" (Gans, King and Mankiw 1999, pp.-334). Since there are only a few sellers, the actions of any one firm in an oligopolistic market can have a large impact on the profits of all the other firms. Due to this, all the firms in an oligopolistic market are interdependent on one another. This relationship between the few sellers is what differentiates oligopolies from perfect competition and monopolies. Although firms in oligopolies have competitors, they do not face so much competition that they are price takers (as in perfect competition). Hence, they retain substantial control over the price they charge for their goods (characteristic of monopolies).

In my discussion I will use the Australian airline industry to present how oligopolies operate, and to show the different behaviours and strategies that arise from the interdependence of firms. I will mainly concentrate on the domestic airline market in Australia. The domestic airline market consists of a duopoly of two firms, Qantas and Virgin Blue. Since Qantas and Virgin are the only two Airlines supplying domestically in Australia, they account for all of the profits in the market and consequently they are in direct competition with each other. Because only two firms are competing, each firm must carefully consider how its actions will affect the other, and how its rival is likely to react. Thus, strategic considerations regarding the behaviour of competitors in this duopoly are essential in order for Qantas and Virgin to set prices.

"Game theory is often used as a model to analyse the strategies of individuals or organisations with conflicting goals" (Waud and Hocking 1992, pp.-334). The economic games that firms play can be either cooperative or non-cooperative. "Cooperative games are those in which participants can negotiate binding contracts that allow them to plan joint strategies" (Pindyck and Rubinfeld 2001, pp.-462). Due to this binding agreement firms don't have to worry about their opponents actions. "Games in which negotiations and enforcements of binding contracts are not possible are known as non-cooperative games" (Pindyck and Rubinfeld 2001, pp.-462), firms independently set their price taking its competitors decisions into account. Non-cooperative games may lead to a price war.

In this industry there is a fair deal of product differentiation. Qantas is a well established airline, while Virgin Blue is a relatively new firm. Qantas differentiates its product from Virgin's through better service, food, comfort, entertainment and safety. While Virgin mainly provides for low income earners, who are not concerned with the luxuries, but only looking for a cheap way to travel. Due to these differences Qantas and Virgin Blue compete through prices. The firm's strategic decisions describe how they make their price decisions. Each firm calculates the...

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