Pricing issues in the United States airline industry
Weiher, Jesse Caldwell
Doctor of Philosophy
This dissertation explores two important issues in the determination of U.S. airline fares: inflation and market power. The first essay deals with the accurate measurement of inflation in the U.S. airline industry by calculating a quality adjusted price index for airfares. This calculation is achieved via an hedonic regression including relevant quality characteristics as well as time dummies. This new price index is compared with the index currently used by the BLS and reasons why the two indices diverge are discussed. Suggestions for a revision of the BLS practices are provided as well as data protocols for its implementation. The second paper examines how market power affects the percentage that a carrier can charge above marginal cost. DOT's DB1A data set (1979--1992) and the DOT's form 41/T300 cost and production data are used to construct the percentage markup in price above marginal cost. This paper then examines how the percentage markup is affected by a number of market variables using reduced form methods. The results indicate that an increase in the Herfindahl Index, leads to increases in the Lerner index for markets with a dominant pair of firms. Airlines that have significant sales in other markets have a higher markup than other airlines and, finally, code-sharing has an insignificant, impact on a carriers' price-cost margins. The third paper extends the analysis of the second paper by formally testing whether particular routes can be classified as competitive, Cournot oligopolistic, or collusive. Again, using DOT's DB1A data set and DOT's form 41/T300 cost and production data set, a model of demand is jointly estimated with the first order conditions for profit maximization (which vary according to market structure). These models are then formally tested using a non-nested likelihood ratio test to determine which market structure dominates. The results indicate that of 3141 routes, 436 are collusive, 1852 are competitive and 838 are Cournot oligopolistic. Collusive routes are naturally monopolistic routes in the sense that carriers would be driven from the market by large economic losses were they forced to compete.