Nonlinear Pricing Strategies and Market Concentration

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NONLINEAR PRICING STRATEGIES AND MARKET CONCENTRATION IN THE AIRLINE INDUSTRY

A Dissertation by MANUEL A. HERNANDEZ GARCIA

Submitted to the Office of Graduate Studies of Texas A&M University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY

August 2009

Major Subject: Economics

UMI Number: 3384249

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NONLINEAR PRICING STRATEGIES AND MARKET CONCENTRATION IN THE AIRLINE INDUSTRY

A Dissertation by MANUEL A. HERNANDEZ GARCIA

Submitted to the Office of Graduate Studies of Texas A&M University in partial fulfillment of the requirements for the degree of DOCTOR OF PHILOSOPHY

Approved by: Chair of Committee, Steven N. Wiggins Committee Members, Li Gan James Griffin Steven L. Puller Head of Department, Larry Oliver

August 2009 Major Subject: Economics

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ABSTRACT Nonlinear Pricing Strategies and Market Concentration in the Airline Industry. (August 2009) Manuel A. Hernandez Garcia, B.A., Universidad del Pacifico, Peru Chair of Advisory Committee: Dr. Steven N. Wiggins This dissertation investigates the effect of market concentration on nonlinear pricing strategies in the airline industry. The study develops a theoretical nonlinear pricing model with both discrete product and consumer types to derive testable implications about the impact of market concentration on the structure of relative prices within a menu of prices. The analysis then uses a unique, airline ticket level data set to test the model predictions. The data set consists of a representative sample of airline tickets purchased between June and December 2004 from one major Computer Reservation System (CRS), for travel in the fourth quarter of the same year. The study restricts attention to 246 domestic routes in the United States, resulting in 878,169 tickets. This unique data set allows us to examine the effect of market structure conditions on relative prices within a menu of fare types with restrictive ticket characteristics. The analysis also contributes to the understanding of how the level of competition in a market affects the dispersion of airline prices. The results indicate that market concentration differentially impacts high versus low priced fares, as predicted by the theoretical model. More specifically, there is a decrease in the ratio of high- to low-quality fares as markets become more concentrated, after controlling for numerous factors that may affect prices through costs and market characteristics. The ratio of medium- to low-quality fares, however, increases with less competition. From a welfare perspective, it is interesting to observe that not all travelers are affected in the same way by a decrease in the level of competition.

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Business travelers, who purchase high priced fares, end up paying relatively lower prices in more concentrated markets while leisure travelers pay more.

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To my father

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ACKNOWLEDGMENTS

I am deeply grateful to my advisor, Steven N. Wiggins, for his guidance throughout the course of this research and for sharing with me a lot of his expertise and research insight. I also want to extend my gratitude to my committee members, Li Gan, James Griffin and Steven L. Puller, and each of my professors at Texas A&M University, especially Qi Li. I thankfully acknowledge financial support from the Fulbright Commission and the Department of Economics at Texas A&M University. Thanks to my...
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