WASHINGTON (AP) _ The Transportation Department on Friday approved the $1.6 billion merger of USAir and Piedmont Airlines, overruling a law judge's opinion that the merger would reduce competition in some markets.

The two airlines had argued that the merger was necessary for them to survive in an industry which has been dominated in recent years by an increasingly smaller number of large airlines.

The agreement, which was announced last March, will create the nation's fifth largest air carrier. It also combines two of the industry's most financially successful airlines.

The decision by the department came despite an administrative law judge's recommendation against the merger. Judge Ronnie Yoder had said the acquisition of Piedmont by USAir would ''substantially reduce'' competition in some markets.

But in its decision, the department said it did not agree with Yoder's assessment. It said there is no barrier for other airlines to enter those markets and that at airports where entry is restricted, nearby airports could provide adequate competition.

USAir issued a statement saying the merger would allow USAir and Piedmont to ''achieve important efficiencies, provide better service ... and compete more effectively with the industry giants.''

''We intend to move promptly to complete the acquisition,'' said USAir Chairman Edwin Colodny.

USAir, which has its headquarters near Washington, offered to buy Piedmont Aviation Inc., which is based in Winston-Salem, N.C., last March for $69 a share.

Although the company's stock has dropped during the recent turmoil on Wall Street, USAir officials have said that the $69-a-share price still stands. Piedmont stock closed at $63 a share in trading Friday on the New York Stock Exchange.

When the merger agreement was announced in March, it was widely expected to get easy government approval. But the department during the summer came under strong criticism for approving airline mergers too easily, raising concern that the deal might not be completed.

Yoder, the administrative law judge in the Transportation Department, raised questions about the merger's impact on competition in a number of markets including New York LaGuardia and Washington National Airports.

America West, a regional airline, had formally opposed the merger, arguing it should not go through without USAir and Piedmont handing over some of the takeoff and landing slots they own at National and LaGuardia.

The department said that issue should be resolved in a separate proceeding.

As for the overall concerns about competition, Matthew Scocozza, assistant secretary for policy and international affairs, said:

''Although some carriers may have advantages in the services and operations cited as barriers by Judge Yoder, those advantages do not prevent new carriers from entering the markets. Some of the advantages can be used by other competing carriers to enter markets served at present by the applicants.''

In such cases as Washington National and New York LaGuardia, where access is restricted to new airlines, ''other airports will provide effective competition,'' wrote Scocozza. He cited Newark International and John F. Kennedy airports in the New York area and Baltimore-Washington International and Dulles International airports in the Washington area.

USAir began purchasing Piedmont stock shortly after the merger was announced, but the stock has been placed in a voting trust, pending on the merger's approval by the Transportation Department.

USAir, based in Arlington, Va., outside Washington, has its major hub in Pittsburgh with much of its route system concentrated in the Northeast. Earlier this year it expanded to the West when it completed the acqusition of Pacific Southwest Airlines.

Piedmont has its largest hub in Charlotte, N.C. and serves 26 states, while concentrating its services in the Southeast, Midwest and parts of the Northeast.

Yoder, in recommending against the merger, said the two airlines are the top competitors in short-haul flights in the eastern part of the United States. He said when combined they would control markets in and out of three airports in New York state - Binghamton, Ithaca and Elmira - as well as at Huntington, W.Va., Myrtle Beach, S.C., and Tri-City, Tenn.

Both the Justice Department and the Transportation Department's public counsel, however, had said that they do not consider the merger anticompetitive.

USAir and Piedmont officials had argued before the Transportation Department that the merger was necessary for them to survive against the ''megacarriers'' created during a series of mergers over the past two years.

During that time, Texas Air Corp., which owned Continental Airlines, purchased Eastern Airlines and People Express; Delta Air Lines has absorbed Western Airlines; Northwest Airlines merged with Republic Airlines; Trans World Airlines bought Ozark Air Lines; United Airlines absorbed the Pacific Division of Pan American World Airways; and American Airlines bought Air California.