Do Airplanes Signal When They Merge?

It was reported today that Southwest Airlines is set to purchase its competitor AirTran for $1.4 billion.  Southwest is paying a 69% premium over the stock price of AirTran in the deal, which drove up the stock prices of both companies immensely when the merger was announced.

This type of merger is called a "Horizontal Merger," defined as the joining of two competing firms.  There's also two other kinds of mergers: Vertical (a company buys one of its suppliers, like Dell buying Intel) and Conglomerate (a business buys a company completely unrelated, such as Ford buying Coke-a-Cola).

The reason that such a horizontal merger may work is if there are economies of scale to be realized and if economic efficiency will increase.  Economies of scale means that the marginal cost of running one larger company would be cheaper than running two separate companies.  Think of it as having to pay only one CEO instead of two, they could by less airplanes, etc.

Economic efficiency refers to the merger's effect on society as a whole.  Because the two companies are coming together to form one larger firm, there will be one less company in the industry and the new firm will be that much closer to being a monopoly.  This will give it a little more control over prices and quantities, but not total control because there are still many other large airlines out there. Lets look at this amazing graph: (btw, this graph is just an illustration and does not represent gains or losses from this airline merger)

The area marked "A" is an income transfer from consumers to the new firm and doesn't matter very much.  The area we're interested in is are "B," which shows us the reduction in cost the new company will see due to the economies of scale. If the reduction in cost is larger than the dead-weight loss created by the merger, then creating the larger firm is better for society and increases economic efficiency. You can see here that area B is clearly larger than the dead-weight loss, so this merger is good for the economy.

Is the Southwest/TranAir merger good for the economy? I have no idea, that would take a lot of research and access to data only their upper-level management would have access to. But I make this promise: if an Eta Sigma Alpha student finds the right answer, you'll get 10 HSA points.

Here's a good article about the merger if you want to read more about the actual acquisition: http://bit.ly/cFjhrT