Questions

1. Consider the domestic airline industry in Australia. Briefly describe and define the
market structure. Provide arguments and suggestive evidence in support of your claims.
Your discussion could address issues such as the market concentration, product
characteristics, how price is determined, whether firms make profits, and entry/exit to this
market. Discuss whether the market structure is likely to change over time (350 words
recommended). (15 marks)

The domestic airline industry in Australia is characterized by an oligopoly market structure. An

oligopoly market structure contains a small number of firms, and these firms face strategic
interactions with each other. Typically, firms in an oligopoly sells similar but slightly
differentiated products. In this case, the product being sold is the transportation of customers but
are slightly differentiated depending flight destinations, in-flight amenities etc.

Market concentration
The market concentration of an oligopoly is very high. A rule of thumb is an oligopoly exists
when the top five firms in a certain industry contributes to more than 60% of total market shares.
For the domestic airline industry, Qantas and Virgin contributes to 43.1% and 30.7% of total
market shares respectively.

Entry/Exit to the Market

There are significant barriers to enter the market including high start-up costs, tight government
regulation and difficulty in employing pilots. Similarly, it is also difficult to exit the market due
to high sunk costs as well as high labour related exit costs.

Price determination
In the domestic airline industry, Qantas and Virgin dominates the market. Therefore, they must
carefully consider how their actions can impact each other and change the way they react
accordingly. This strategic behaviour between the airlines will ultimately determine the price.
More specifically, the domestic airline industry implements the Cournot’s Duopoly Model. This
model states that firms will achieve Nash Equilibrium, meaning each firm will set the most
appropriate/optimal price given its competitor’s behaviour. If Nash equilibrium cannot be
achieved, firms can involve in a price war or collusion.

Profit
In terms of profit, domestic airlines will typically earn a profit in the long run due to them
implementing a third-degree price discrimination which is when consumers are separated into
‘markets’ and charges a different price for each market. Third degree price discrimination
maximises profit.

Future
I think the market structure will remain the same because the airline industry will always remain
difficult to enter, especially due to the high start-up costs. Similarly, it is also difficult to exit the
market and there is no incentive to exit now that the pandemic is coming to an end.

2. At a recent Australian Financial Review event, Qantas chief executive Alan Joyce said
current crude oil prices of around $US130 ($179) a barrel — up from $73 at the start of
2022 — translated to a 7 percent increase in the average airfare, with another 1 percent
rise for every $4 per barrel after that. Use of a diagram and explain in words, how the price
and the quantity traded in equilibrium would change following an increase in the price of
oil? How important is the price elasticity of demand in determining the new equilibrium
price? (150 words recommended). (10 marks)

Short Run
A rise in oil prices encourages firms to increase production due to the law of supply. Therefore,
this shifts the SRAS curve to the left. Demand is not impacted in the short run as oil is a
necessity and inelastic good, thus demand curve does not shift.
Long Run
Oil will become more price elastic as consumers are able to shift to alternatives like using
electric powered cars. As a result, the demand curve would shift to become less steep. The
supply side of things, firms are encouraged to find new oil supplies. If successful, supply curve
will shift upwards.

Price elasticity
Price elasticity of demand impacts the new equilibrium price. If a good is elastic, then a
subsequent increase in price would lead to a large decrease in quantity demanded and thus
significantly influence the equilibrium price. Conversely, if a good is inelastic, then there would
be little no influence on equilibrium price.

Word count: 495 words

 References

Australia’s renewed domestic market competition hots up. (2021, December 13). CAPA - Centre

for Aviation. https://centreforaviation.com/analysis/reports/australias-renewed-domestic-market-

competition-hots-up-590458

Investopedia. (2022). How does the law of supply and demand affect the oil industry?

Investopedia. https://www.investopedia.com/ask/answers/040915/how-does-law-supply-and-

demand-affect-oil-industry.asp

Kenton, W. (2020, September 6). What is Concentration Ratio? Investopedia.

https://www.investopedia.com/terms/c/concentrationratio.asp

Lesson summary: equilibrium in the AD-AS model (article). (2018). Khan Academy.

https://www.khanacademy.org/economics-finance-domain/ap-macroeconomics/national-income-

and-price-determinations/equilibrium-in-the-ad-as-model-ap/a/lesson-summary-equilibrium-in-

the-ad-as-model

Lope Gallego. (2017). Cournot duopoly | Policonomics. Policonomics.com.

https://policonomics.com/cournot-duopoly-model/

Osborne, M. J. (1997). Cournot’s duopoly model. Www.economics.utoronto.ca.

https://www.economics.utoronto.ca/osborne/2x3/tutorial/COURNOT.HTM

Pettinger, T. (2018, October 20). Effect of Higher Oil Prices. Economics Help.

https://www.economicshelp.org/blog/1919/oil/effect-of-higher-oil-prices/