An examination of airline safety in a structural model of the airline industry

When consumers cannot verify a product's quality even after they have consumed the product, they must find other means of assessing product quality. In this study, I examine whether consumers are able to do this in the case of airline safety. I use a structural model to analyze consumer and carrier behavior in a full oligopoly market setting with differentiated airline products. I construct aggregate preferences for air travel consistent with data on individual consumer carrier choices from the Department of Transportation's Origin and Destination Survey. The structure placed on the estimation allows for decomposing separately the effect of safety on the demand conditions and on the cost conditions.; In addition to the oligopoly model, I construct a structural equation of the process that generates accidents. I also specify a model of Bayesian updating; as consumers observe additional flight outcomes, they update their beliefs about a carrier's accident probability. I test whether consumers are fully informed about airline safety despite not observing it, and whether accidents are informative about unobservable safety. I conclude that consumers learn about the provision of airline safety from flight outcomes, and that accidents adversely affect the demand of other carriers.; Finally, I use the estimates of the structural model to simulate the short-run market effects of altering FAA safety standards regarding maintenance expenditures. The carriers' profits are higher when they are able to choose their optimal maintenance provision without any constraints even if the constraint does not bind their own maintenance decision. As expected, consumer welfare falls with the elimination of the government minimum standard. Simulations also indicate that carriers, as well as consumers, would prefer an independent entity to certify its chosen safety provision rather than have the FAA mandate a minimum provision. Certification eliminates the uncertainty about safety provision and makes it more profitable to provide additional maintenance.