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Sunday, November 17, 2013

Current Events Lesson - American Airlines Merger

One of the biggest economic stories of the past few months has been the proposed merger between American Airlines and U.S. Airways.  Up until a few days ago, this merger was being challenged by the Department of Justice for violating antitrust laws.  Such a vivid example of oligopoly/monopoly (and of monopoly pricing and price discrimination) being played out in the news seems like an obvious choice for this week's free lesson plan.

The United States' antitrust laws are designed to keep businesses in the same industry competitive by ensuring there are plenty of firms competing for consumer business.  When one company gains a disproportionately large share of an industry's business, it becomes difficult for other firms to compete.  Thus, smaller firms go out of business, which further reduces competition.  Whenever competition is reduced, firms are able to increase price above the equilibrium level.  Firms cannot charge whatever they want--since consumers will simply choose not to purchase the item if prices are too high--but they can increase prices to the point of monopoly pricing.

The U.S. government initially chose to file an antitrust lawsuit in this proposed merger because of these fears of price increases.  General economic theory tells us that less competition means higher prices for consumers.  But the airline industry is an incredibly complex industry with various algorithms for determining the price of a particular ticket at a particular time.  For example, there may be hundreds of people flying on a certain flight, but it is likely that many of the passengers paid radically different prices than the others.  Such ambiguity makes the economics of this situation rather difficult to ascertain.

As a result, the Department of Justice was willing to allow the merger to continue as planned as long as American Airlines and U.S. Airways agreed to a few concessions.  Most notably, they must give up gates and routes at some of the nation's busiest airports.  Government officials feel that this will help smaller airlines compete with American Airlines once the merger is complete.  When that merger is complete, there will be three major airlines dominating the industry in the United States, with American Airlines being the largest (along with Delta and United).

The videos I use for this lesson are included both here and as hyperlinks in the free download.  The first video (aired on ABCNews on 13 August) provides background information to the government's attempt to block the merger.  The second video (created by the Associated Press on 12 November) provides information about how and why the merger was allowed to take place.

  • The history of antitrust laws in the United States, especially the lawsuits against Standard Oil and AT&T
  • The characteristics of an oligopolistic market (A few sellers that dominate most of the market in a particular industry, game theory, etc.)
  • The difference between an oligopoly and a monopoly (the airline industry is technically an oligopoly, but certain routes between two cities are usually dominated by one airline, meaning the market for that route is controlled by a monopolist.)
  • Monopolistic pricing (a monopolist still prices where MC=MR, but his MR curve is downward sloping.  This allows him to charge a price higher than the perfectly competitive equilibrium price.)
  • Price discrimination (a monopolist charges different prices to different customers based on elasticity of demand
    in order to capture as much of the consumer surplus as possible.)

I hope you and your class find this lesson engaging and invigorating.  Please leave me any questions or comments.  Enjoy!