The Effect of Predatory Pricing in the American Airline Market on Consumer Surplus

Abstract

Predatory pricing happens when a dominant firm prices its goods below cost with the purpose of driving out competition. This paper assesses the impact of price predation on consumers in the American airline market, using Spirit Airlines Inc. v. Northwest Airlines Inc. as the case study. Northwest Airlines was found guilty of conducting price predation against Spirit Airlines in 1996 for the routes Detroit-Boston and Detroit-Philadelphia. I find that Northwest’s price predation lowers consumer surplus by driving competition out of the market, which reduces consumer choice and allows the surviving dominant company to raise its prices to recoup losses. I also predict that Northwest Airlines would be found guilty in other jurisdictions such as in New Zealand, Australia, the UK, and finally the US, after researching and summarising their legislations surrounding price predation and abuse of market power. I came to these conclusions by firstly calculating the total and variable costs of the airlines affected by the price predation with data publicly available from the Transtats database. I then estimated a demand model for the airline market. I also computed counterfactual Bertrand equilibrium prices for the two routes of interest. Finally, I calculated the changes in consumer surplus due to the price predation.