An Empirical Study of the Effect of the Internet on Fares in the U.S. Airline Industry

A reduction in search costs is generally believed to make markets more competitive. However, the effect may be mitigated or amplified if consumers must pay costs for switching products. This paper investigates how search costs affect prices in the presence of switching costs using U.S. domestic airfare data for 2000-2010. The airline industry experienced a dramatic decrease in search costs with increasing Internet use in the 2000s. At the same time, the industry is known for its frequent flyer programs (FFPs), which increase switching costs for consumers. We use the average network size of airlines in a market as a proxy for switching costs related to FFPs and Internet usage as a proxy for (the inverse of) search costs. The results show that increasing Internet usage lowers airfares but that the effect is smaller for markets with a larger average network size.