*We would like to thank two anonymous referees, as well as seminar participants at LSE, INSEAD, Toulouse, Mannheim, Bergen, and the European University Institute for their comments and suggestions. Special thanks are due to Timothy Besley, Stephen Nickel, Pierre Regibeau, and Paul Seabright. We are grateful to the German Science Foundation (DFG) for financial support. The second author is currently on leave as Chief Competition Economist, European Commission.
ENDOGENOUS COSTS AND PRICE-COST MARGINS: AN APPLICATION TO THE EUROPEAN AIRLINE INDUSTRY*
Article first published online: 1 SEP 2006
The Journal of Industrial Economics
Volume 54, Issue 3, pages 351–368, September 2006
How to Cite
NEVEN, D. J., RÖLLER, L.-H. and ZHANG, Z. (2006), ENDOGENOUS COSTS AND PRICE-COST MARGINS: AN APPLICATION TO THE EUROPEAN AIRLINE INDUSTRY. The Journal of Industrial Economics, 54: 351–368. doi: 10.1111/j.1467-6451.2006.00292.x
- Issue published online: 1 SEP 2006
- Article first published online: 1 SEP 2006
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.