A STRUCTURAL MODEL OF INTRA EUROPEAN UNION DUOPOLY AIRLINE COMPETITION.

Given inherited regulations and European Union (EU) airline industry characteristics, how should the potential benefits stemming from the new regulatory environment be evaluated? What are the effects of abandoning (binding) collusive practices in intra-EU markets? What kind of airline EU merger policy would be the most appropriate? These are the main questions this paper attempts to answer. To this end, a model of intra-EU airline competition which takes the main characteristics of the industry into account is analysed, that is: the new EU competition rules provided by the Third Package and the structure of EU airline networks. The main features of the new EU competition rules concern pricing freedom and market access, which were traditionally regulated through bilateral agreements between governments/countries. The most remarkable feature concerning the structure of EU airline networks is that EU airlines typically operate hub and-spoke (HS) networks. In contrast to the US, where HS networks principally emerged as a consequence of US airline deregulation (1978), in Europe HS networks have arisen as a consequence of geographic and/or regulatory characteristics. Various researchers have stressed the importance of networking and multiproduct aspects in airline economics (see S?rndal and Statton, 1975; Pavaux, 1984; and Caves et al, 1984, among others). Recently, Brueckner and Spiller (1991) provided an analytical framework to study the effect of competition in airline HS networks. The aim of this paper is to extend their approach to a two-country/two-airline model which captures some important EU airline industry specificities. In fact, while Brueckner and Spiller (1991) analyse the effect of an exogenous change in the number of firms serving a particular market, this paper examines the possible effects and the social welfare consequences of the gradual EU airline liberalisation. The model presents various competition scenarios, from (binding) cartel agreement (pre-liberalisation phase) toward more competitive behaviour. Finally, the model offers some insights into the important merger issue. It seems clear that the future of the EU airline industry will depend, to a large extent, on a successful EU merger policy.