Competition in the European Aviation Market: The Entry of Low-Cost Airlines

This paper investigates the price setting behavior of full service airlines in the European passenger aviation market. We develop a model of airline competition, which accommodates various market structures, some of which include low-cost players. Using data on published airfares of Lufthansa, British Airways, Alitalia and KLM for the main city-pairs from Italy to the rest of Europe, our empirical findings substantially confirm the propositions of the theoretical model. We find that competition among full service carriers appears to affect the price levels of business and leisure segments asymmetrically: there are small reductions in the leisure segments and significant reductions in the business segment of the aviation market. In contrast, competition with low cost carriers reduces both the business and leisure fares of full service carriers quite uniformly with an emphasis on the mid-segment fares.