Quantity Discounts and Capital Misallocation in Vertical Relationships: The Case of Aircraft and Airline Industries

42 Pages Posted: 1 Mar 2016

See all articles by Ken Onishi

Ken Onishi

Board of Governors of the Federal Reserve System

Date Written: February 29, 2016

Abstract

I study transactions between aircraft manufacturers and airlines as well as airlines' utilization of their fleet. Aircraft production is characterized by economies of scale via learning-by-doing, which creates a trade-off between current profit and future competitive advantage in the aircraft market. The latter consideration makes large buyers more attractive than small buyers and induces quantity discounts. The resulting nonlinear pricing strategy may distort both production and allocation in favor of large buyers. In the data, there is a negative correlation between the size of aircraft orders and the per-unit price, and a positive correlation between the price paid and the utilization rate of the aircraft model. The pattern in the data suggests that the manufacturers' price discrimination leads to misallocation of aircraft.

To assess whether there is an inefficient allocation, I construct and estimate a dynamic model of the aircraft market that includes a model of utilization. Using the estimated model, I conduct counterfactual simulations where I find that uniform pricing increases aircraft production by 10% and total welfare by 1.6%.

Keywords: Vertical Relationships, Nonlinear Pricing, Dynamic Models

JEL Classification: L11, L51

Suggested Citation

Onishi, Ken, Quantity Discounts and Capital Misallocation in Vertical Relationships: The Case of Aircraft and Airline Industries (February 29, 2016). Available at SSRN: https://ssrn.com/abstract=2739658 or http://dx.doi.org/10.2139/ssrn.2739658

Ken Onishi (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th St and C Ave, NW
Washington, DC 20551
United States

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