Three Essays on Incorporating Service and Product Attributes into Economic Models

Student thesis: Doctoral thesis


The goal of this dissertation is to explore the effect of changing service characteristics on product cost, price and eventually profitability, or in the case of a product that is a service, changing the characteristics of service delivery. The specific focus is not on physical characteristics that can differentiate products (in the airline industry a 200-mile flight vs 700-mile flight, or in the shelving industry 600 lb. holding capacity vs 400 lb.), but on the characteristics of the transaction and the services provided as part of the product. Throughout this thesis we refer to these generically as “output attributes” and use the term “product” to mean either a product or service. Using a cost-based approach and the tools of productivity and efficiency analysis, we develop a measure of product differentiation by output attribute and then use that measure to explore how the inclusion of the measure affects three different economic models. The empirical setting for all three chapters is the US domestic airline industry. The first chapter focuses on cost, introduces the measure of differentiation through attributes, and applies it to a model studying price dispersion. Previous studies show that competition affects price dispersion but disagree on the direction of change. To explain this contradiction, this chapter introduces a novel method of measuring product heterogeneity which collects the cost impact of the level of differentiation in a market. Applying this method, we find that the response of price dispersion to changes in competition is conditioned by differentiation. We empirically test our method on 73,981 observations of airfare data from 2002 through 2016. This chapter’s contributions are extending knowledge on the effect of competition on price dispersion and introducing a method of measuring market differentiation. The main objective of the second chapter is to study the effect of product differentiation on price formation in the airline industry using a hedonic model. For this purpose, we introduce the concept of a core product and examine how differentiation by output attribute beyond the core effects pricing and mark-ups. We measure differentiation from the core product using a Konüs type index of differentiation that is based on cost functions. In this chapter we study how using this index, measures of market power, and controlling for core product cost, can improve the stability and results of a hedonic price model. The model is empirically tested on 103,980 observations of quarterly US domestic airfare data between 2002 and 2016. The third chapter turns to the question of profitability. The US Airline industry swung from $31 billion in losses over the eight-year period 2002 to 2009 to $90 billion in profits over the seven-year period 2010 to 2016. This reversal of fortune was not driven by specific airlines but can be observed industry wide. To fully explore this change we decompose annual profitability change over the fifteen-year period and analyze the economic drivers, with a focus on the driver of product differentiation. The inclusion of product differentiation, an economic driver not typically included in the analysis of financial performance, is one of the primary contributions of this chapter. This chapter introduces a novel method of decomposing profitability change and uses the combination of a standard cost function paired with a non-standard revenue function. To fully understand this effect, we examine these financial performance measures for twenty individual carriers in the US airline industry between 2002 and 2016.
Date of Award29 Sept 2020
Original languageEnglish
SupervisorEmili Grifell-Tatjé (Director)


  • organització industrial

Cite this