University of Auckland

The Smoking Gun? Competition and Predation in the Trans-Tasman Air Travel Market

Email address: t.hazledine@auckland.ac.nz

JEL Classifications: D4 L1 L4 L9

Abstract:
This paper proposes and demonstrates a new method for testing for predatory behaviour by incumbent oligopolists towards new entrants. The traditional test for predation, known as the Areeda-Turner Rule, focuses on the level of price relative to average variable cost, such that if P < AVC, the incumbents cannot be maximising profits even over the short run, and so are predating. The obvious objection to this test (apart from difficulties in measuring variable costs) is that just about all oligopoly models predict that price will fall after the entry of an additional competitor: who is to say that even an unsustainable price cut is not just the natural outcome of the market becoming structurally more competitive? We answer this objection by taking the modelling one level deeper. We ask what type of oligopoly ‘game’ is being played in the market post-entry, and compare it with the pre-entry game. If oligopoly behaviour changes substantially in the direction of becoming more ‘competitive’, then we may have found a ‘smoking gun’ – circumstantial evidence pointly strongly towards predation (but falling short of directly incriminating evidence, such as records of email conversations indicating intent to predate). Our approach is implemented with data on the two million annual flights across the Tasman Sea that separates the main cities of New Zealand and Australia. The market has long been dominated by a duopoly of national carriers -- Air New Zealand and Qantas – who for about a year in 1995/96 faced competition from a new-firm entrant, Kiwi International Airlines. We find that the incumbents’ behaviour pre-entry was quite close to Cournot-Nash, but that it became much more competitive during the period of triopoly competition, suggesting predation. After the exit of Kiwi, behaviour immediately became less competitive, but it did not return to pre-entry levels, and indeed has more recently tended back towards less cooperative duopoly pricing, perhaps to discourage any other new or existing airline from again disturbing the market.

PDF file of paper: hazledine.pdf

Session: Empirical Issues in Industrial Organization and Development

Time: Sunday, 8 July, 2:15pm - 3:45pm

Room: F