Wednesday, October 20, 2021

Does Sunk Cost Affect Prices? Evidence from the U.S. Airline Industry

Does Sunk Cost Affect Prices? Evidence from the U.S. Airline Industry

 

Long Shi

Xi'an Jiaotong University; Xi'an Jiaotong University

Qihong Liu

University of Oklahoma - Department of Economics

Myongjin Kim

University of Oklahoma

 

Abstract

In contrast to the extensive literature on behavior bias by individuals, studies on behavior bias by firms have been relatively scarce. We explore the possibility of the latter in the context of U.S. airlines, where fuel hedging leads to lump sum gain or loss which is sunk to airlines' pricing decisions. Our results show that the (sunk) hedging gain or loss affects airlines' ticket prices. In particular, a 10% reduction in the reported fuel cost (due to hedging gain) leads to a 2.2% reduction in ticket prices. Moving onto non-price decisions, we find that hedging gain leads airlines to use larger aircrafts and reduce airtime of their flights, but has no impacts on the number of routes and flights which airlines operate. Our results provide empirical evidence that fixed/sunk costs can affect firms' price and non-price decisions, establish a link between financial market and product market competition, and have important welfare/policy and managerial implications.

https://lawprofessors.typepad.com/antitrustprof_blog/2021/10/does-sunk-cost-affect-prices-evidence-from-the-us-airline-industry.html

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