This study provides empirical evidence documenting how price dispersion moves with the business cycle in the airline industry. Performing a fixed-effects panel analysis on seventeen years of data covering two business cycles, we find that price dispersion is highly pro-cyclical. This effect is especially pronounced for legacy carriers relative to low-cost carriers. We show that our empirical result is consistent with firms' implementing second-degree price-discrimination tactics.

A parsimonious theoretical model of second degree price discrimination suggests that the business cycle will affect the degree to which firms are able to price discriminate between different consumer types. We analyze price dispersion in the airline industry to assess how price discrimination can expose airlines to aggregatedemand fluctuations. Performing a panel analysis on 17 years of data covering two business cycles, we find that price dispersion is highly pro-cyclical. Estimates show that a rise in the output gap of one percentage point is associated with a 1.9 percent increase in the interquartile range of the price distribution in a market. These results suggest that markups move pro-cyclically in the airline industry, such that during booms in the cycle, firms can significantly raise the markup charged to those with a high willingness-to-pay. The analysis suggests that this impact on firms' ability to price discriminate results in additional profit risk, over and above the risk that comes from variations in cost. * We thank