2004/05 Rybczynski Prize Essay

Casual observation suggests that deregulation of the European Union airline market has led to lower economy class airfares. Low-cost carriers have entered the market, forcing traditional airlines to reduce their economy fares to compete. By contrast, there is less competition in the business class market, and fares remain high. Business class fares are substantially above economy class fares, despite the seemingly small difference in the cost of supplying the two types of seat. This paper provides empirical evidence in support of these observations. A brief history of the European airline market and 1993 liberalisation process is given, followed by an empirical comparison of the fares of a traditional carrier with those of low-cost carriers. Next, a theoretical model of an airline’s cost function is developed, and used to test the hypothesis that mark-ups above cost for economy class airfares are lower on routes in the liberalised EU market than on EU to non-EU shorthaul routes. The latter provide a proxy for EU routes prior to liberalisation since the regulatory structure on these routes now is the same as that which existed in the EU prior to liberalisation. Finally, business class fares are compared with economy class fares, providing evidence that EU business class fares are marked-up substantially above cost, and that competition in the business class market is limited.

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