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ENDOGENOUS COSTS AND PRICE‐COST MARGINS: AN APPLICATION TO THE EUROPEAN AIRLINE INDUSTRY *
Author(s) -
NEVEN DAMIEN J.,
RÖLLER LARSHENDRIK,
ZHANG ZHENTANG
Publication year - 2006
Publication title -
the journal of industrial economics
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.93
H-Index - 77
eISSN - 1467-6451
pISSN - 0022-1821
DOI - 10.1111/j.1467-6451.2006.00292.x
Subject(s) - monopoly , economics , market power , microeconomics , limit price , de facto , product (mathematics) , order (exchange) , point (geometry) , fixed cost , price level , monetary economics , finance , geometry , mathematics , political science , law
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.