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Sunk costs, contestability and airline monopoly power

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Abstract

This paper examines the effects of sunk costs and potential competition on pricing behavior in monopoly airline markets. We find little evidence to support the proposition from contestable markets theory that the level of sunk costs influences pricing by monopolists. Rather, the results support the view, consistent with numerous game theoretic oligopoly models, that the costs and the price-cutting reputation of potential entrants influence incumbent behavior. These results suggest that contestability theory may not be robust. Even in the markets characterized by increasing returns to scale, the perfectly contestable market may not be a useful welfare standard.

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Authors and Affiliations

  1. J. L. Kellogg Graduate School of Management and The Transportation Center, Northwestern University, 60208, Evanston, IL, USA

    Margaret A. Peteraf

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  1. Margaret A. Peteraf
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Additional information

I am grateful to Richard Levin, Merton J. Peck, Sharon Oster, Paul MacAvoy, Dan Kaplan, Michael Levine, David Sappington, Andrea Shepard, and Diana Strassman for their advice. Participants at numerous workshops also made useful comments. Steven Davis, Tadas Osmolshis, and Maeve O'Higgins provided help with the data and technical assistance. I acknowledge financial support from Yale University and the Eno Foundation for Transportation. The usual disclaimer, of course, applies.

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Peteraf, M.A. Sunk costs, contestability and airline monopoly power. Rev Ind Organ 10, 289–306 (1995). https://doi.org/10.1007/BF01027076

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