Answer to Question #320599 in Macroeconomics for Rose

Question

Interpret and explain the diagram below, which illustrates the effect of airline

regulations by the civil aeronautics board. Indicate what effect the regulation will

have on airlines’ sales, output and profit, and also what consumers are losing or

gaining in the process.

Answer 1

One of the industries with the greatest potential to benefit from the Single European Market is civil aviation, which has been highly regulated by European governments. The deregulation of civil aviation in the US since the late 1970s has provided valuable evidence about the nature of the airline industry and its response to the liberalization of conditions of entry by new carriers. We examine the US experience and look at the changing regulatory framework for the European industry. We also consider the main sources of market failure in air transport. The lessons of the US experience are threefold. First, deregulation can in principle produce major gains to consumers without damaging the long-run profitability of carriers, by reducing the high costs of operation of European airlines. Second, congestion problems, especially the availability of landing slots at airports, need to be managed effectively to prevent incumbent carriers squeezing out new entrants: we recommend a system of slot auctions to achieve this. Third, in spite of relatively low sunk costs of entry to the industry, there remain significant opportunities for the exercise of market power by incumbent carriers. Deregulation of entry needs, therefore, to be supplemented by a vigorous competition policy, especially with regard to the approval of mergers.