Price Discrimination and Business-Cycle Risk

35 Pages Posted: 23 Mar 2015

See all articles by Marco Cornia

Marco Cornia

Johns Hopkins University - Department of Economics

Kristopher Gerardi

Federal Reserve Bank of Atlanta

Adam Hale Shapiro

Federal Reserve Bank of San Francisco

Date Written: March 2011

Abstract

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.

Keywords: airlines, price discrimination, price dispersion, markup, business cycle

JEL Classification: D4, L9, L1, E3

Suggested Citation

Cornia, Marco and Gerardi, Kristopher S. and Shapiro, Adam Hale, Price Discrimination and Business-Cycle Risk (March 2011). FRB Atlanta Working Paper No. 2011-3, Available at SSRN: https://ssrn.com/abstract=2481146 or http://dx.doi.org/10.2139/ssrn.2481146

Marco Cornia

Johns Hopkins University - Department of Economics ( email )

3400 Charles Street
Baltimore, MD 21218-2685
United States

Kristopher S. Gerardi (Contact Author)

Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States
404-498-8561 (Phone)

HOME PAGE: http://sites.google.com/site/kristophergerardishomepage/

Adam Hale Shapiro

Federal Reserve Bank of San Francisco ( email )

101 Market Street
San Francisco, CA 94105
United States

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