Endogenous Costs and Price-Cost Margins: An Application to the European Airline Industry

18 Pages Posted: 4 Sep 2006

See all articles by Damien J. Neven

Damien J. Neven

University of Geneva; Centre for Economic Policy Research (CEPR)

Lars-Hendrik Röller

ESMT European School of Management and Technology; Centre for Economic Policy Research (CEPR); WZB Berlin Social Science Center - Competitiveness and Industrial Change

Zhentang Zhang

DIW Berlin, German Institute for Economic Research

Abstract

This paper allows for endogenous costs in the estimation of price cost margins. In particular, we estimate price-cost margins when firms bargain over wages. We extent the standard two-equation set-up (demand and first-order condition in the product market) to include a third equation, which is derived from bargaining over wages. In this way, price-cost margins are determined by wages and vice versa. We implement the model using data for eight European airlines from 1976-1994, and show that the treatment of endogenous costs has important implications for the measurement of price-cost margins and the assessment of market power. Our main result is that observed prices in Europe are virtually identical to monopoly prices, even though observed margins are consistent with Nash behavior. Apparently, costs had been inflated to the point that the European consumers were faced with a de facto monopoly prices.

Suggested Citation

Neven, Damien J. and Röller, Lars-Hendrik and Zhang, Zhentang, Endogenous Costs and Price-Cost Margins: An Application to the European Airline Industry. Journal of Industrial Economics, Vol. 54, No. 3, pp. 351-368, September 2006, Available at SSRN: https://ssrn.com/abstract=928030 or http://dx.doi.org/10.1111/j.1467-6451.2006.00292.x

Damien J. Neven (Contact Author)

University of Geneva ( email )

Graduate Institute of International Studies
CH-1211 Geneve 4
Switzerland

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Lars-Hendrik Röller

ESMT European School of Management and Technology ( email )

Schlossplatz 1
Berlin, 10178
Germany

HOME PAGE: http://www.esmt.org/eng/faculty-research/lars-hendrik-roeller/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

WZB Berlin Social Science Center - Competitiveness and Industrial Change ( email )

Reichpietschufer 50
10785 Berlin
Germany
+49 30 2549 1440 (Phone)
+49 30 2549 1442 (Fax)

Zhentang Zhang

DIW Berlin, German Institute for Economic Research ( email )

Mohrenstraße 58
Berlin, 10117
Germany

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
24
Abstract Views
932
PlumX Metrics