Pass-through of airline cost changes - What does economic research say?

Airlines costs change on a day to day basis. An important question for airlines and regulators is whether airlines are able to pass-through cost changes into their prices. In this paper we investigate which pass-through rates are most appropriate based on economic theory and empirical literature. According to economic theory the pass-through of costs depends strongly on the type of cost increase (one firm or sector wide) and market conditions (monopoly, oligopoly, perfect competition). A pass-through rate of 100 percent is often assumed based on the reasoning that the aviation sector is highly competitive. We argue however that most aviation markets can be better characterised as oligopolies or monopolistic competition. In such markets one-firm cost changes will be passed-through for less than half and sector-wide cost changes are passed through by more than 50 percent, depending on the market conditions. Other factors that influence the pass-through rate are available airport capacity (congestion), scope for cross-subsidization, the fairness of competition and the price sensitivity of demand. Little empirical evidence on the pass-through of costs exists. This probably has to do with the difficulty to obtain reliable fare data and with the difficulty to isolate the price effects of a certain cost change.