This question explores whether U.S. airline companies use their market power by charging higher air fares. The data consists of average fares on the most popular routes (e.g., Boston-Chicago) for the year 2000. Below you will find OLS estimates of a regression relating average airfare in city-pair ? to several explanatory variables:
lprice=4.4 - 0.04 dist - 0.06pass - 0.8 mkts - 0.4 mkts^2
(0.1) (0.02) (0.01) (0.3) (0.2)
where lprice is the logarithm of the average fare on the given route, dist is distance of the route (in thousands of miles with a range running from 0.1 to 3), pass is average number of passengers per day (in thousands, with a range 0.01 to 8), and mkts is the market share of the biggest airline carrier on the given route (the average is 0.3, i.e., 30%). Heteroskedasticity-robust standard errors are given in parentheses.
a) Based on the OLS estimations, and assuming the OLS assumptions hold, what is the marginal effect of the market share of the largest carrier on prices evaluated at the average of that market share?
b) We are also interested to know how precisely this effect is measured. If you had the data, how would you go about finding the standard error of this estimate?
c) Does your answer in (a) support the hypothesis that firms use their market power to charge higher prices?
d) How would you test whether market power is used the same way on more popular and less popular routes? (Write down the model and the hypotheses, and describe the test procedure.)