Measurment of a Cost Function for US Airlines: Restricted and Unrestricted Translog Models with Energy Cost Perturbations

Abstract

This thesis continues and expands several themes from previous studies of commercial airline cost functions. A well specified industrial cost function reveals characteristics about the market players, such as economies of scale and the cost elasticities with respect to operational styles. These parameters are updated, the experimental design reworked and new analysis is given to describe the spectrum of choices facing airline firms in recent times. I first construct a cost function for recent data using methods similar to Caves, Christensen and Tretheway (1984). As an energy intensive business, the US airline industry has seen its energy cost share rise and fall over time with potentially destabilizing effects. The model in this paper allows the energy cost share to interact with other variables and illuminate what factors may exacerbate cost sensitivity to energy prices. It was found that fuel cost shares tend to be higher with older equipment, smaller fleet sizes, and to be increasing in aircraft size and seating density. The translog results include a positive cost of older aircraft designs, suggesting that airlines with poorer access to capital may suffer a cost disadvantage, particularly during a fuel spike. The model does not reject constant returns to scale (CRS) for fleet expansion, or IRS in aircraft size.