Yes, Competition Really Exists
One of the main assertions of economics that people find hard to accept is that markets, not sellers, set prices. In other words, economists often assume that “the market” sets the price, and companies sell at the market price, choosing how much to sell, but not what price to charge. People — including, people taking an introductory course in economics, and journalists — find this hard to believe, probably because when they want to buy something, they walk into a store and see prices on tags, or call up a company and ask what the price is and get an answer.
The problem is, when economists say “the market not the seller sets the price,” we don’t mean “the market comes to the grocery and attaches a pricetag to a box of crackers,” but rather, if the seller sets a price that’s too high, no one will buy — and if they set a price that’s too low, they’ll be out of business, or at least out of stock in rather short order.
Joshua Sharf points out a recent example of how this works, in what is called in the airline industry “the Southwest effect” — that is, Southwest Airlines enters a market, uses its lower costs to set lower prices than other airlines, and those other airlines have to reduce their prices to Southwest’s.
October 27, 2005: The Southwest Effect?
Southwest Airlines finally announced its initial routes and fares from Denver, and as promised, it’s a small start. With 13 daily departures, they’ll have more than jetBlue and Airtran, but fewer than such titans as United (309), Frontier (153), and Great Lakes (66). (Hey, don’t laugh. Great Lakes can get you from Denver to Kingman, AZ in just five easy hops.)
They’ll fly to Chicago ($79 one-way), Las Vegas, and Phonenix ($59 one-way, each), starting on January 3, with a 21-day advance purchase. Just for fun, I looked up the current low airfares from Denver to each of those cities, roundtrip, January 5, returning January 8. They are, Chicago: $252, Las Vegas, $206, and Phoenix, $178. (Source: Orbitz)
Now, of course, I’ll have to track those numbers daily until service starts, to see if there really is going to be a Southwest effect.
October 28, 2005: Southwest Effect II
Well, that sure didn’t take long. Next year’s fares from DIA to Chicago, Vegas, and Phoenix drop to match Southwest’s. So far, not all the carriers who had been low-fare have moved to match, and for some reason United it still $40 higher on the Las Vegas route. It’ll be interesting to see which airlines try to maintain higher fares, and for how long.
In other words, those other airlines don’t get to set their prices. At most, the lowest cost producer gets to set the price for the entire market. (But even that price is constrained by what buyers are willing to pay.)
