Airline Regulation and Wasteful Quality
Alex Tabarrok (reference below, video on right) analyzes the airline regulation to provide examples of the second third and fourth unintended consequences of Price Floors:
- Lost gains from trade (deadweight loss)
- Wasteful increases in quality
- A misallocation of resources
Regulated price floors produce wasteful increases in quality
Tabarrok analyzes the impact of airline regulation in the United States. From 1938 to 1978 the Civil Aeronautics Board regulated airlines with regulations that restricted entry and kept air fares above market levels. (The price of flights on regulated routes, between states, was twice the price of flights on the unregulated intra state flight between Los Angeles and San Francisco.) The result was that airlines competed on the basis of quality rather than price.
Tabarrok says that this resulted in “too much quality” in the sense that airlines were paying more for the competitive quality improvements than they were valued by customers. He illustrates this with the following diagram.
When airline regulation ended in 1978 air fares declined dramatically and the quantity of flights and choices increased. Although quality declined, most customers found the lower fares
Regulated price floors produced a misallocation of resources
Tabarrok notes that during the period of regulation resources were clearly misallocated because new entrants, such as Southwest Airlines which has since become one of the world’s biggest and well-run airlines, were prevented from entering the industry.
From http://www.mruniversity.com/node/201805, accessed 1 May 2016.
- In the 1970s, AirCal and Pacific Southwest Airlines flew only within California. As we mentioned, the federal price floors didn’t apply to flights within just one state. A major route for these airlines was flying from San Francisco to Los Angeles, a distance of 350 miles. This is about the same distance as from Chicago, Illinois, to Cleveland, Ohio. Which flight had a nicer meal?
Atlas topic, subject, and course
Alex Tabarrok, Price Floors: Airline Fares (8-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/price-floor-effect-on-quality-airline-deregulation, accessed 1 May 2016.
Page created by: Ian Clark, last modified 1 May 2016.
Image: Alex Tabarrok, Minute 0:13 of Price Floors: Airline Fares (8-minute video), Principles of Economics – Microeconomics, Marginal Revolution University, at http://www.mruniversity.com/courses/principles-economics-microeconomics/price-floor-effect-on-quality-airline-deregulation, accessed 1 May 2016.