DP926 | Competition, Market Niches, and Efficiency: A Structural Model of the European Airline Industry

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In this paper we specify and estimate a structural model of competition for the European airline industry to assess the potential for price reductions if competition increases. The model has two distinguishing features: First, we allow for firms to make short- and long-run decisions by explicitly estimating a structural, two-stage game. In that sense, our model allows for dynamics that do not rely on the switching regime literature. Unlike some of the other contributions in the literature, we also explicitly estimate the entire structural model, that is demand, cost (short and long run), and conduct. Second, our paper distinguishes between domestic market niches and competition at the international level, by specifying a product-differentiated game in the second stage. This distinction carries important policy implications. In general we find that relatively little market power is due to price collusion. In fact, firms compete significantly more than a standard Nash game would suggest. On the other hand, significant monopoly power is identified in domestic markets. Given that prices are not high because of cartel pricing, airline prices in Europe might come down more gradually as efficiency increases and market niches are abolished.