Economics for Today 9th Edition by Irvin Tucker

Exercise 3

DOES AIRLINE DEREGULATION MEAN FRIENDLIER SKIES?
Applicable Concept: regulation versus deregulation
A much publicized case of deregulation is the airline industry. Under regulation by the Civil Aeronautics Board (CAB), airfare competition and the incentive to control costs were reduced or eliminated. The CAB set both fares and routes for carriers. Unable to compete with price, the carriers could compete only with costly non-price competition, such as advertising. Once the CAB authorized a carrier to provide service between two cities, the frequency of service remained unregulated. When carriers purchased fleets of planes and provided too many flights for their protected routes, profits were squeezed because the percentage of seats filled with passengers (load factor) fell, and the average cost rose. Carriers would then attempt to boost profits by lobbying the CAB for higher fares. In addition to eliminating price competition between established carriers, the CAB restricted entrants into the industry. From 1938 until 1977, the CAB never awarded a major route to any new airline.
Successful deregulation of an industry would be expected to provide the following three results:
• The average price of the service falls.
• The volume and variety of services rise.
• New firms enter the industry, and other firms fail and exit the industry.
The Airline Deregulation Act of 1978 provided these results by changing the structure and business behavior of the airline industry. Although the Federal Aviation Administration (FAA) would still regulate the safety of air service, the CAB was eliminated under this act in 1984, and price competition produced the expected results of lower fares and greater quantity of service. The average passenger price per mile for a flight declined continuously from 1978 to half that rate over the next 30 years on an inflation-adjusted basis, saving consumers billions of dollars in lower fares. Over this same period, the fall in fares contributed to a tripling of passenger miles flown per year.
The airline deregulatory movement is not without criticism. One concern is that lots of airlines went "belly up," and these exits from the industry increased the percentage of all domestic air travel controlled by the industry's largest carriers. Moreover, under the pressure of competition, carriers searched for ways to cut costs, and they created the hub-and-spoke delivery system. This system allows carriers to gather passengers from the "spoke" routes by using smaller, less efficient planes and fly the passengers from the hub in fully occupied, bigger planes at lower cost. Many carriers have gained near monopoly power in "hub" airports. These dominant hub carriers can control access to terminal gates, takeoff time slots, and baggage service, and they can charge smaller airlines high rates for using these airport rights.
Today, deregulation continues to exert downward pressure on fares, and old-guard carriers scramble to compete with low-cost carriers such as Southwest and JetBlue. Low-fare tickets, cyber-fares, and frequent-flier miles are popular. Should the airlines remain deregulated or return to a government-enforced cartel? Critics point to airlines that are in financial trouble. Defenders of deregulation argue that growth of market concentration and its abuses can be controlled by enforcing antitrust laws and allowing global competition.
Prior to deregulation, critics argued that airline safety would suffer. Instead, although the Federal Aviation Administration's budget was cut following deregulation, the accident rate involving fatalities has fallen. Give a rationale for why the critics' prediction did not come to pass.