QUALITY COMPETITION, INDUSTRY EQUILIBRIUM, AND EFFICIENCY IN THE PRICE-CONSTRAINED AIRLINE MARKET. IN: AIR TRANSPORT

Abstract

This paper describes and attempts to quantify the relationships between slack capacity, passenger costs and overall service quality in the airline market. Optimal level and structure of airfares is suggested, and this estimated solution is contrasted with the market equilibrium now obtained under regulation. In the scheduled air transportation industry, an important component of quality is endogenous to the equilibrium, and a proxy measure of this quality characteristic can be estimated. The analysis presented here shows that ignoring the price-quality tradeoff can lead to significant divergences between the optimal and existing price-quality options. It is implied that a greater number of price-quality options is best, and additional techniques should be developed for price-quality differentiation within the regulatory environment. It is also clear from this analysis that the costs of regulated carriers are high because the price level is high, i.e, cost is price-determined rather than price-determining. Regulators do not need to be given explicit, direct control over capacity and quality because of the proclivity of carriers to compete intensively with scheduling rivals. Through the control of fares, the regulator has an efficient means of controlling total capacity and bringing about a more efficient level and structure of price-quality options.