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A parsimonious theoretical model of second degree price discrimination suggests that the business cycle will affect the degree to which firms are able to price-discriminate between different consumer types. The authors analyze price dispersion in the airline industry to assess how price discrimination can expose airlines to aggregate-demand fluctuations. Performing a panel analysis on seventeen years of data covering two business cycles, they find that price dispersion is highly procyclical. Estimates show that a rise in the output gap of 1 percentage point is associated with a 1.9 percent increase in the interquartile range of the price distribution in a market.
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