Quality Competition, Industry Equilibrium, and Efficiency in the Price-Constrained Airline Market

Abstract

Recent literature on regulated markets has focused on the ramifications of controlling price as a means of regulating a monopolist’s rate of return.1 There exist, however, a great variety of regulated competitive markets where the implications of price control are qualitatively different. That is, while the control of price to restrain a monopolist’s profit rate may affect the technical efficiency of its production of a specifically defined output, the implications of price restraints in nonmonopoly markets are more typically manifested in the overall quality level of the output, an issue of allocative efficiency. There are many examples of such regulated markets (and imperfect private cartels) which, although price constrained, reach an equilibrium through vigorous nonprice competition which bids away most or all implicit rents. In these markets the existence of rents (or the regulator’s control of rents) is more directly related to the nature of restraints on entry rather than to the control of price. Examples include commercial banking, stock brokerage, real estate brokerage, motor trucking, taxicab service, and, of particular interest here, air transportation.

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