How Does the Internet Affect Prices? A Look at the Airline Industry

1. How Does the Internet Affect Prices? A Look at the Airline Industry Marika Cabral Advisors: Silke Januszewski and Ross Starr Many people predicted price structures in consumer industries would be completely transformed by the extension of internet use into the everyday lives of Americans. The internet offers consumers a way to easily compare prices. This would likely lead to a drop in average prices and a narrowing of price dispersion among comparable goods. With the introduction of the internet, the airline industry has changed dramatically. Most airline tickets were booked through travel agencies before widespread internet availability. As access to the internet becomes widely available, more travelers are choosing to compare and purchase airline tickets themselves. One would expect prices to be affected due to this major shift in purchasing behavior. I examined airfares and internet penetration levels for the years 2002 and 2004. Controlling for typical variables that influence airfares, I attempted to identify the effect of internet penetration levels on average airfares and price dispersion. Additionally, I tested for the effect of the internet on low-cost carriers’ prices to compare this to the effect on major network carriers’ prices. To illustrate the effect I found of the internet on average fares, I present the following example. Comparing a direct roundtrip ticket from Denver to Los Angeles and a direct roundtrip ticket from Los Angeles to Denver, one can control for many route-specific characteristics. In 2004, the percentage of internet users of the total population in California was 56.75% and in Colorado it was 65.1%. The average airfare paid for a direct roundtrip ticket from Los Angeles to Denver was $280.76. This can be compared to the average airfare of $259.12 paid for a direct roundtrip ticket from Denver to Los Angeles. The difference in average prices between the two tickets is sizable: $21.64. LAX origin 2002 LAX origin 2004 DEN origin 2002 DEN origin 2004 Points in the graph above represent average airfares by airline for direct roundtrip routes between Los Angeles and Denver. Approach The airline data used in my research is a 10% sample of domestic airline tickets collected by the Bureau of Transportation Statistics. I obtained state-level internet data from reports published by the National Telecommunications & Information Administration. I fitted models, both with and without fixed effects, after organizing the data by directional-route and airline. By fitting a model with route fixed effects, I was able to find the average effect of internet growth over time when each route is examined separately. Additionally, I fit a different model using route characteristics that relate to price such as measures for population and tourism at the endpoint cities. This model allowed me to examine the change in prices due to internet penetration over time and across locations. Findings The models I have fitted indicate that dispersion of prices and average prices charged by major network carriers decrease as internet penetration increases. Dispersion of prices and average prices charged by low-cost carriers are not affected as dramatically according to the models. The downward effect on average prices is smaller for major carriers on routes where they compete with low-cost carriers.