How Does the Internet Affect Prices

1
How Does the Internet Affect Prices? A Look at
the Airline Industry
Marika Cabral Advisors Silke Januszewski and
Ross Starr
Many people predicted price structures in
consumer industries would be completely
transformed by the extension of internet use into
the everyday lives of Americans. The internet
offers consumers a way to easily compare prices.
This would likely lead to a drop in average
prices and a narrowing of price dispersion among
comparable goods. With the introduction of the
internet, the airline industry has changed
dramatically. Most airline tickets were booked
through travel agencies before widespread
internet availability. As access to the internet
becomes widely available, more travelers are
choosing to compare and purchase airline tickets
themselves. One would expect prices to be
affected due to this major shift in purchasing
behavior. I examined airfares and internet
penetration levels for the years 2002 and 2004.
Controlling for typical variables that influence
airfares, I attempted to identify the effect of
internet penetration levels on average airfares
and price dispersion. Additionally, I tested for
the effect of the internet on low-cost carriers
prices to compare this to the effect on major
network carriers prices.

To illustrate the effect I found of the internet
on average fares, I present the following
example. Comparing a direct roundtrip ticket
from Denver to Los Angeles and a direct roundtrip
ticket from Los Angeles to Denver, one can
control for many route-specific characteristics.
In 2004, the percentage of internet users of the
total population in California was 56.75 and in
Colorado it was 65.1. The average airfare paid
for a direct roundtrip ticket from Los Angeles to
Denver was 280.76. This can be compared to the
average airfare of 259.12 paid for a direct
roundtrip ticket from Denver to Los Angeles. The
difference in average prices between the two
tickets is sizable 21.64.
LAX origin 2004
LAX origin 2002
DEN origin 2002
DEN origin 2004
Points in the graph above represent average
airfares by airline for direct roundtrip routes
between Los Angeles and Denver.
Approach The airline data used in my research is
a 10 sample of domestic airline tickets
collected by the Bureau of Transportation
Statistics. I obtained state-level internet data
from reports published by the National
Telecommunications Information Administration.
I fitted models, both with and without fixed
effects, after organizing the data by
directional-route and airline. By fitting a
model with route fixed effects, I was able to
find the average effect of internet growth over
time when each route is examined separately.
Additionally, I fit a different model using route
characteristics that relate to price such as
measures for population and tourism at the
endpoint cities. This model allowed me to
examine the change in prices due to internet
penetration over time and across locations.
Findings The models I have fitted indicate that
dispersion of prices and average prices charged
by major network carriers decrease as internet
penetration increases. Dispersion of prices and
average prices charged by low-cost carriers are
not affected as dramatically according to the
models. The downward effect on average prices is
smaller for major carriers on routes where they
compete with low-cost carriers.