A parsimonious theoretical model of second degree price discrimination suggests that the business cycle will affect the degree to which firms are able to price-discriminate between different consumer types. We analyze price dispersion in the airline industry to assess how price discrimination can expose airlines to aggregate-demand fluctuations. Performing a panel analysis on seventeen years of data covering two business cycles, we find that price dispersion is highly procyclical. Estimates show that a rise in the output gap of 1 percentage point is associated with a 1.9 percent increase in the interquartile range of the price distribution in a market. These results suggest that markups move procyclically in the airline industry, such that during booms in the cycle, firms can significantly raise the markup charged to those with a high willingness to pay. The analysis suggests that this impact on firms' ability to price-discriminate results in additional profit risk, over and above the risk that comes from variations in cost.
JEL classification: D4, L9, L1, E3
Key words: airlines, price discrimination, price dispersion, markup, business cycle
The authors thank Jim Adams, Ana Aizcorbe, Ben Bridgman, Abe Dunn, Matt Osborne, and Kyle Hood for helpful comments and suggestions. The views expressed here are the authors' and not necessarily those of the U.S. Bureau of Economic Analysis, the U.S. Department of Commerce, the Federal Reserve Bank of Atlanta, or the Federal Reserve System. The research presented here was primarily conducted while at the Federal Reserve Bank of Boston. Any remaining errors are the authors' responsibility.
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