Nonlinear Pricing and Market Concentration in the U.S. Airline Industry∗

This paper provides new evidence on the impact of market concentration on airlines’ nonlinear pricing strategies. Under a second-degree price discrimination setup, where firms compete via a collection of quality and price pairs, we derive testable implications about the effect of market structure on a firm’s relative price schedule. We then test these predictions using a unique dataset of airline ticket transactions during the fourth quarter of 2004 that allows us to group fares according to certain characteristics and restrictions. We find that market concentration differentially impacts various types of fares. In line with our model predictions, there is a non-negligible decrease in the ratio or quality premium of highto low-type fares as we move to less competitive markets. The ratio of mediumto low-type fares, however, appears to increase with market concentration. Overall, the observed relative pricing pattern reaffirms the negative correlation between market concentration and price dispersion found in previous studies. From a welfare perspective, it is interesting to observe that not all travelers are affected in the same way by a decrease in the level of competition. Business travelers, who purchase high-price tickets, end up paying relatively lower fares in more concentrated markets while leisure travelers pay more.