EconEdLink Navigation BarStandards Contact Lessons Current Events WebLinks DataLinks CyberTeach
A premier source of classroom tested, Internet-based economic lesson materials for K-12 teachers and their students

Sign up! | Forgot Password

Online Lesson

About this lesson
 grade level: 9-12
EconEdLink Line Break
curriculum standards:
9
EconEdLink Line Break
author: Council for Economic Education Technology Staff
EconEdLink Line Break
More lessons from this author
EconEdLink Line Break
posted on: May 11, 1998
EconEdLink Line Break
State Standards
EconEdLink Line Break
Printable Glossary
EconEdLink Line Break

Thinkfinity EconEdLink Banner

Teacher's Version

This lesson provides you with the resources that you will need to teach this lesson. We have also provided a link for your students to follow this lesson online. The link below contains only the information your students need:

http://econedlink.org/?a=22

EconomicsMinute

Airline Mergers, Software Industry Monopolies: Contestable Markets?

Key Economic Concepts:

Description:

Mergers within industries such as banking, telecommunications, and airlines have created a stir among consumers who charge that economic freedom and efficiency are being sacrificed in favor of corporate profits. The theory of contestable markets postulates that firms in imperfectly competitive markets may act as though they operate in a purely competitive market when entry and exit are perfectly (or nearly) costless. Firms generate a normal profit when faced with the threat of additional market consumers can continue to enjoy the lower prices that accompany competition; the merger between firms and subsequent strengthening of business concentration may not have detrimental effects on consumers. The United States Department of Justice has used this theory on antitrust cases to rule in favor of the defendant. Students will read an overview of the contestable markets hypothesis and determine whether or not it is applicable to the airline mergers and to the Microsoft antitrust case. In this lesson, you will determine whether mergers and monopolies within certain industries have negative effects on consumers based on the theory of contestable markets.

Introduction:

Mergers within industries such as banking, telecommunications, and airlines have created a stir among consumers who charge that economic freedom and efficiency are being sacrificed in favor of corporate profits. The theory of contestable markets postulates that firms in imperfectly competitive markets may act as though they operate in a purely competitive market when entry and exit are perfectly (or nearly) costless. Firms generate a normal profit when faced with the threat of additional market entrants. As a result, consumers can continue to enjoy the lower prices that accompany competition; the merger between firms and subsequent strengthening of business concentration may not have detrimental effects on consumers. The United States Department of Justice has used this theory on antitrust cases to rule in favor of the defendant. Students will read an overview of the contestable markets hypothesis and determine whether or not it is applicable to the airline mergers and to the Microsoft antitrust case.

In this lesson, you will determine whether mergers and monopolies within certain industries have negative effects on consumers based on the theory of contestable markets. plane

"The most cited example of a contestable market is the airline industry. Assume there are just two airlines flying the Omaha - Chicago route. If entry and exit were costly, the market would not be contestable and the two incumbent airlines might realize substantial economic profits from their protected market position.

But in fact additional airlines can enter and leave this particular segment of the air transportation market with minimal cost. The reason is that the relevant capital equipment - the airplanes themselves -- are highly mobile. Hence, if an additional airline were to enter and find the Omaha-Chicago route to be unprofitable, it could simply "pull out" by flying its equipment to some other route. The awareness of the possibility of costless entry will compel the two airlines currently flying the Omaha-Chicago route to provide their transportation services efficiently and at prices which yield only a normal profit." (Source: McConnell and Brue. "Economics, 12th Edition." McGraw-Hill, 1994.)

Resources:

Process:

Read the following articles and determine how the information given supports or refutes the contestable markets theory.

Fears of Monopolies in the Sky Lawmakers Push to Keep Big Airlines from Taking Over [1]

Airline Pacts May Face Scrutiny -- Washington Post
"Facing growing public concern over airline service, lawmakers are worried that proposed alliances of the nation's six largest airlines could further reduce flights and increase fares.

The Justice Department will seek to block any such agreement that would "restrain trade and lessen competition,'' said John Nannes, deputy assistant attorney general for the department's antitrust division. The airlines say the alliances will give travelers a much wider choice of destinations than they now have on a single carrier.

Read abstracts of cases and determine how the theory of contestable markets would apply to each:

Printable Version of "Fears of Monopolies in the Sky" [2]

Cases related to merger policy

Read the following article by Ralph Nader and answer the questions below.
The Microsoft Menace: Why I'm leading a crusade to stop its drive for cyberspace hegemony. [3]

It has been argued that the software market is a contestable one: entry
and exit are virtually costless.

What are the costs (if any) of entry into the word processor market?
What about the costs of developing a new web browser?

How does this case parallel that of the Gillette case (below)?

Cases that feature entry

"In U.S. v. The Gillette Company and Parker Pen Holdings, the government argued that entry was unlikely due to the brand name barriers as well as the time required to design and manufacture a pen. The government's expert argued further that product repositioning was unlikely, sunk costs were large, and consumer loyalty reduced the disciplining effects of entry. In contrast, Carl Shapiro, the parties expert argued that entry barriers were low. The judge agreed that entry barriers were low."

Do you think that Microsoft should split up into smaller companies?

Links Used:

1. ^ ^ "Fears of Monopolies in the Sky" - (www.sfgate.com) An article on how lawmakers are pushing to keep big airlines from taking over the industry.
2. ^ ^ "Fears of Monopolies in the Sky: Printable Version" - (www.sfgate.com) This site contains an article on how lawmakers are pushing to keep big airlines from taking over the industry.
3. ^ ^ "The Microsoft Menace" - (slate.msn.com) This 1997 article by Ralph Nader discusses what he sees as a Microsoft monopoly in personal computers, Internet publishing, and electronic commerce.

Teacher Reviews

November 7, 2007
For an airline industry to make more money they need to make less flights to cities where other planes are already going. If you have 30 flights to a city, the price would be cheap. If you have three flights to a city, prices would be expensive. I think that Microsoft should break into smaller companies. If they do, they would be able to satisfy their customers more easily, and they would be able to make more money that way. I also think that barriers to entry should be much higher. I think you should have to pay millions of dollars to get into the world processor market if you would like to make any money and compete with much larger corporations.
- Ben Borodkin  

November 7, 2007
The Airline Industry should be a competitive industry between at least ten companies. If it were ruled by only one or two, the prices would rise and there would be no room for market entry. The government should leave the airline industry alone unless a monopoly forms.
- Matt Harlan  

November 7, 2007
I think that airlines have the right to put their price at any level that they want to while running the risk of being outpriced by other companies. As long as there is no monopoly on any one route, a competing airline can always lower their prices to attract more consumers.
- Brian Brotherton  

November 7, 2007
Contestable markets act as if they are in a perfectly competitive market although they are in an imperfect one and that entry into their markets are costless. Consumers continue to enjoy low prices from this "competition" and are not affected by the mergers of firms or strengthening of business concentration. As a result, the United States usually rules in the favor of the defendant. The airline is the largest example of these contestable markets. Airlines are attracted to routes that give profit and pull out if profits go down. The government worries that alliances in airlines could greatly decrease flights and raise air fares. The government sets a block on such alliances from forming. It's been argued whether the software market is low or high entry. In a legal battle, the government argued that entry was unlikely because of the way in which certain pens are designed. The judge ruled in favor of the fact that entry barriers were low.
- Ben Alexander  

November 7, 2007
I think the difference btween the costs of the two airlines in the first reading is outrageous! I don't think that Microsoft should split up into smaller companies. It still has competition from Apple to make better quality products. However, I do believe that that relationship should be watched carefully by the government. Seeing as there is really only two big companies in that particular market, they could easily join together and agree on a certain price. This would be bad for the economy and for the people buying their products. After all, we don't have a lot of other options. I believe in the contestable market theory partially. I think that every type of good should have at least three or four major firms in it. This would still keep up the reduction of price and better quality.
- Corey Acosta  

Insert a comment, suggestion or review of this lesson here. The comments will not appear immediately due to a time delay to allow for a review by a member of our staff.