Baynes Welch
Whether competition in the US airline industry leads to an increase or decrease in price discrimination still remains a hotly debated topic. This is important because price dispersion is apparent in numerous and extensive forms for the airline industry. It has been estimated that ticket prices range as much as 36% from the average ticket cost (Borenstein). The airline industry serves millions of customers a year who all must decide between varied and competitive prices. Furthermore, due to the high fixed costs and government regulations, the airline industry is a natural oligopoly. Only a few, large firms operate in the US, thus the addition or loss of even one firm could greatly alter the amount of price dispersion. However, it is unclear whether price discrimination increases, decreases, or changes at all with an increase in competition. Originally, in 1994, Borenstein and Rose argued that competition has a positive relationship with price discrimination for airlines. However, more recent papers have shown there is still a divide in opinion. Gerardi and Shapiro represent Borenstein and Rose’s dissidents while Stavins and Mantin concur with the initial conclusions while Gaggero’s work in the UK airline industry mirrors Gerardi’s.
Borenstein initially used Gini coefficients to determine the degree of difference of ticket prices in the airline industry and then looked at whether price discrimination or differences in cost structure caused this. The Gini coefficient was .18, corresponding to an average difference of 36% between two randomly selected tickets. Different programs such as Frequent Flyer Programs incentivize customers to concentrate their business within one company, which allows firms to price discriminate better. However, there are two sources of cost differences which both derive from peak-load periods, where added congestion creates new costs. Systematic peak-load pricing represents the anticipated costs of maximum capacity and can be predicted in advance. Stochastic peak-load pricing occurs when the demand for a flight is unknown until equipment-scheduling decisions are made, therefore making it impossible to control for in the data.
References
Borenstein, Severin and Rose, Nancy L. Competition and Price Dispersion in the U.S. Airline Industry. Journal of Political Economy; Aug. 1994, Vol. 102 Issue 4, p. 653.
Gaggero, Alberto A. Piga, Claudio A. Airline Market Power and Intertemporal Price Dispersion. Journal of Industrial Economics. Dec2011, Vol. 59 Issue 4, p552-577
Gerardi, Kristopher and Shapiro, Adam. Does Competition Reduce Price Discrimination? New Evidence from the Airline Industry. Journal of Political Economy; Feb. 2009, Vol. 117 Issue 1, p1-37.
Mantin, Benny; Koo, Bonwoo. Dynamic price dispersion in airline markets. Transportation Research: Part E. Nov2009, Vol. 45 Issue 6, p1020-1029.
Stavins, Joanna. Price Discrimination in the Airline Mharket: The Effect of Market Concentration. Review of Economics & Statistics; Feb2001, Vol. 83 Issue 1, p200.
I just wrote about this on another page, but it seems low-cost airlines such as Ryanair are the only ones currently remaining profitable. Their philosophy is that customer service doesn’t involve “big fine wines” but just a cheap, on-time flight that doesn’t lose your bags (words of Ryanair CEO Michael O’Leary). There does seem to have been an extremely large increase in ticket prices, and the low-cost airlines are benefitting from this trend. Ryanair is now the most profitable airline in Europe and flies 175 million passengers annually. It remains to be seen whether the big players in the industry will be able to keep up, but it doesn’t seem that way as of now.