ENDOGENOUS COSTS AND PRICE-COST MARGINS: AN APPLICATION TO THE EUROPEAN AIRLINE INDUSTRY

• Published in: The Journal of industrial economics Vol. 54; no. 3; pp. 351 - 368
• Main Authors: NEVEN, DAMIEN J., RÖLLER, LARS-HENDRIK, ZHANG, ZHENTANG
• Format: Journal Article
• Language: English
• Published: Oxford, UK Blackwell Publishing Ltd 01.09.2006; Blackwell Publishers
• Subjects: Air transportation industry; Airline industry; Airlines; Cost estimates; Costs; Estimating techniques; Life cycles; Marginal cost pricing; Marginal costs; Market competition; Market power; Market prices; Oligopoly; Passengers; Prices; Product markets; Studies; Europe
• ISSN: 0022-1821; 1467-6451
• DOI: 10.1111/j.1467-6451.2006.00292.x

This paper allows for endogenous costs in the estimation of price cost margins. In particular, we estimate price-cost margins when firms bargain over wages. We extent the standard two-equation set-up (demand and first-order condition in the product market) to include a third equation, which is derived from bargaining over wages. In this way, price-cost margins are determined by wages and vice versa. We implement the model using data for eight European airlines from 1976-1994, and show that the treatment of endogenous costs has important implications for the measurement of price-cost margins and the assessment of market power. Our main result is that observed prices in Europe are virtually identical to monopoly prices, even though observed margins are consistent with Nash behavior. Apparently, costs had been inflated to the point that the European consumers were faced with a de facto monopoly prices.