Thursday, July 8, 2010

Does the Market Power of a Dominant Airline Spill Over to Its Rivals?

Blog readers may be interested to read Alessandro V.M. Oliveira's Does the Market Power of a Dominanet Airlne Spill Over to its Rivals? (Latin American Center for Transportation Ecomomics Working Paper, June 16, 2010) (available from SSRN here).  From the abstract:

Some of the main sources of market power in the airline industry are related to route and airport dominance. What is more, Borenstein (1989) found evidence that the market power of a dominant airline does not spill over to its rivals on the same route. Here I investigate this lack of “umbrella” effect by examining an air shuttle market with recent liberalization in which the major carrier has more than 50 % of the market share of both route and endpoint airports. Dominance in air shuttle markets is crucial since most passengers are usually very time-sensitive and a firm with a broader portfolio of departures is more likely to conquer their loyalty. The main contribution of the paper is the use of a competition model rather than a non-structural pricing equation. By employing a demand system with stages of budgeting and a conduct parameter to capture rivalry among heterogeneous players, I estimate the extent of deviation from Bertrand-Nash equilibrium after deregulation measures and two episodes of cost shock. As route-level marginal costs are unobservable, I then use observed shifters at the aircraft level to control for costs and economies of density. The model also permits an evaluation of the impact of the regulatory reform on the behavior of firms. The main finding is that the dominant carrier managed to persistently sustain higher-than-average markups whereas the smaller rivals had marginal-cost or below-marginal-cost pricing. Additionally, the higher estimated markups of the dominant firm were not due to anticompetitive behavior but solely to product differentiation - a higher perceived product quality by very time-sensitive consumers. This is indicative not only that the regulatory reform was successful in enhancing competition but also, from an antitrust perspective, it induced a situation in which the potential effects of market dominance on margins were offset.

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