How do firms compete?

Competition is not a very straightforward concept to define. One can think about markets being competitive if market players actively work to attract consumers via low prices, and periodically launch price wars. However, price, or rather airfare in our case, is just the beginning of the story. Firstly, as already noted, the full price of travel includes not only the monetary expenses, but also expected schedule delay. So, an airline offering five flights per day may end up offering an average passenger a “cheaper” product as compared to a carrier who only flies once per day, even if the latter airline's airfare is lower. A business traveller taking a late afternoon flight with the former airline instead of waiting until the following day to return home with the carrier offering less frequent service may be more than happy to pay higher airfare for a more convenient schedule.

Economists think about any product or service on a market as possessing three key characteristics relevant to analysis of competition: price, location and quality. The latter two terms are broader than just physical location or things we usually associate with quality (such as how luxurious, safe or durable a product is). While location can indeed represent a physical place (e.g., a supermarket's address), it can also signify other product characteristics (such as cocoa content in chocolate or colour of a car). Product quality can indeed include durability, safety, refund conditions, customer service, or even such intangible things as brand reputation.

There is however one major difference between the notions of “location” and “quality”: when prices are the same, different customers will disagree on their ranking of products or services with different “locations”, but not with different “quality”. Other things being equal, I prefer buying my groceries in a supermarket that is most easily accessible from the place where I live (which might not necessarily be the closest in terms of distance from my home). And since people live in different locations, they will inevitably disagree on which supermarket is the most convenient for them. I prefer dark chocolate, while my children will only eat milk chocolate.