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Yet, the ATA study monetheless lumps these 1,198 local service routes into their results, claiming (with no support) that these too would be candidates for elimination. Their inclusion in the graphs (as pointed out by George Eads) appears to be a smoke screen aimed at buttressing their argument.

Having hopefully laid to rest the specter of mass cancellation of flights (since this tactic is presently available and has not been exercised), I will now turn to what I feel is the relevant issue before the committee: "What are the costs and benefits associated with the deregulation of prices for the trunk airlines?" From an economic perspective, the following arguments can be advanced:

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The

1. Currently all price variations are subject to CAB approval. delay factor in seeking and getting approval for fare changes inhibits rapid adaptation to changing demand patterns in the market. In a "free" market no longer would this flexibility be retarded. 2. Fixing prices reduces competition and protects inefficiency. Basically each airline firm faces three kinds of competition: substitution effect traveling via another mode of transportation, price effect traveling on another airline that flies more cheaply, and differentiation effect traveling on another airline because it is more preferred for reasons other than price. When prices are set, the first two components of competition are also fixed. Thus, intra-industry competition has been substantially reduced. If the set price is too low, firms will not make a profit and will eliminate service (get out of the market), which they can do, in general. If the set price is "on the mark" no harm will have been done, But, if the price is too high, the consumer is in effect subsidizing the trunks with the implicit sanction of the government. Carriers which normally could not derive a profit can continue to exist on this subsidy. Furthermore, by their very existence they raise the cost of entry to the market. Thus, other firms, presently outside of the market, might be able to fly routes more economically, but current market penetration by inefficient carriers prevents their entrance into the market place.

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3. Due to reduced price competition, the airline industry may tend
to overallocate expenditures in several areas as advertising and
other non-price promotional categories.

4. There is no real justification for setting prices. The airline
industry is not monopolistic, nor is it a public utility.

Certainly,

minimum safety standards must be maintained; but allowing price
competition has no bearing on this issue.

I have argued from an economic perspective why deregulation should be undertaken. The gnawing question of what would then happen still remains. Would prices remain fixed or go down? Would service decrease or increase? No one has a crystal ball. The ATA looked at the problem only from the service angle; I believe their examination was faulty. According to its Phase 9 opinion in the Domestic Passenger Fare Investigation, the CAB concludes that price setting results in an elimination of excess profits via a supersaturation of flights in the market (thus diminishing load factors to the breakeven level). If the trunk market were deregulated, the following fare-service situations could occur for a given city-pair:

1. No change in price because the regulated price accurately reflected the free market clearing value. In that case the trunks would have no incentive to change their service (everything else remaining the same).

2. Price of fares decrease because the public "subsidy" has been eliminated. Indeed, service most likely would be curtailed somewhat, the amount depending on both the price and the service elasticities of demand. The airlines would become more competitive and efficient; their scheduling times would cater more to the variations of customer demand. The profit picture of the trunks would not significantly change; in neither the pre- nor the postderegulation periods would they be making excess profits. In fact, if anyone would be adversely affected, it would be the equipment manufacturers. The public would be better off because their fares would be reduced, and the airlines would be more rapidly responsive to their changing demand patterns. The amount of the drop in service, I feel, would not be significant. In any event,

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the wholesale cancellation of scheduled flights would not occur for

reasons mentioned previously.

Since the simulation model has not provided definitive answers to the questions posed by the committee, the next task is to seek the appropriate avenue of investigation. There are basically the three approaches mentioned by Dr. James in his letter:

1. Build a macroeconomic model. To construct such a model from scratch in which one could place faith in its output would be a most difficult task.

2. Build a simulation model that appropriately reflects the problem at hand. To incorporate competition, service elasticity of demand, and correct the misallocation of costs via the city-pair method would be a formidable job.

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3. Study the effects of non-regulation in price in some of the larger states say California and Texas. The market in these states could then serve as a microcosm for a nationwide projection. In particular, I feel that a more thorough analysis of fare and service rate changes should be made with regard to the entrance into the market of Pacific Southwest Airlines (PSA) and Southwest Airlines (WN).

PREPARED STATEMENT OF GEORGE W. DOUGLAS

I am grateful for the opportunity to come before you today to comment on the regulation and performance of our airline industry. In the current inflationary environment it is particularly appropriate that your committee undertake to examine the operations and policies of the Civil Aeronautics Board. For while in the early years of the industry the modus operandi and protective policies of the Board may have served a useful role, they are in large measure now outmoded and now serve primarily to significantly increase the costs, energy usage, and prices of air transportation. Certainly in an era of inflation, energy shortage, and general financial stringency we can ill afford to perpetuate these costly and wasteful practices.

I should like to note at the outset that I do not attribute this state of affairs to venality of the regulators; they have not structured or regulated the industry so as to bestow excessive profits on the air carriers. Rather, the effect of the traditional regulatory practices and policies of the CAB has been substantial increases in the costs of the carriers and fares paid by the public for air travel. While the regulatory policies which increase costs and prices are numerous, by far the dominant aspect of waste is associated with the excessive level of empty seats carried in the system. While the nature of the market requires that some proportion of the seats on average be unfilled, the level which prevails is excessive. I have calculated that from this source alone, the costs and fares of passengers in 1969 were in the range of $366 million to $538 million in excess of the fares they would have paid in the absence of this waste. While I have not access to current data which would enable me to completely reestimate these results for 1974, by extrapolation they would be on the order of $850 million. One can gain a similar "real world" perspective of these costs by comparing the fares which prevail in the intrastate markets of California and Texas and those of similar interstate markets on the east coast. I have described these fares in table 1, and as as you can see those in the CAB regulated interstate markets are from 29 percent to 109 percent higher. I have also calculated in an earlier study the fares which could prevail in other interstate markets, taking into account all those factors which would affect the level of efficient costs, such as distance, market density, aircraft type, service quality and convenience. These "optimal" fares and the actual coach fares of 1972 are reported for several markets in table 2. While some minor portion of the observed differences can be attributed to other sources (i.e., weather and traffic delays, terminal costs and landing fees), the major reason why the California and Texas carriers can operate profitably at such a considerably lower fare is their significantly higher load factor (i.e., proportion of the total seats filled). Since most of the costs in air transport are simply those of flying the aircraft from terminal to terminal, clearly the average cost per passenger is reduced by increasing the number of passengers per flight. There is absolutely no reason why the invisible state boundaries over which the aircraft pass on these and other interstate routes should change the nature of the airline markets so that these passengers should continue to pay these excessive fares.

TABLE 1.-COMPARISON OF FARES IN SELECTED INTRASTATE AND INTERSTATE MARKETS (DECEMBER 1974)

TABLE 2. ESTIMATES OF OPTIMAL AIR COACH FARES AND ACTUAL FARES, SELECTED MARKETS

1 Adjusted for incidence of discount fares (see CAB docket 21866-9, exhibit BC-6006). Source: George W. Douglas and James C. Miller, III, "Economic Regulation and Domestic Air Transport," The Brookings Institution, Washington, 1974.

The ostrich-like attitude of the CAB in ignoring the lessons of the California experience and in not seeking the manifest benefits which could be obtained for the travelling public generally can only be regarded as scandalous. This attitude of the Board was not based on ignorance; as early as August 1965, a CAB staff report carefully pointed out the fares, costs and profitability in the California intrastate markets. (See S.L.R. Brown and Associates, "Traffic, Fares and Competition/ Los Angeles-San Francisco Air Travel Corridor." Staff Research report No. 4, Research and Statistics Division, Bureau of Accounts and Statistics, August 1965).

To understand how these cost and fare differentials arise between the interstate routes under CAB regulation, and the intrastate routes, which are not, one must look to the nature of the airline markets under CAB regulation. The principal aspects of CAB regulation which have brought us the high cost-high fare markets are those affecting price competition and entry. Effective price competition (where it in fact exists) in the unregulated industries serves an important role in both keeping prices in line with the lowest possible costs of production of goods of a given quality, and in forcing producers to produce efficiently. On examination of the history of CAB policy in this area, one can only conclude that its principal thrust has been to discourage or suppress price competition among the carriers. Carriers are discouraged from competing with price because fare changes must be filed with the Board, and are subject to challenge by their rivals. Having observed a pattern of disapprovals, they understandably seek other avenues of rivalry.

Complementing the discouragement of price competition is the Board's consistent sheltering of the industry from competition by new firms. Upon the establishment of the CAB in 1938, the existing carriers were given certificates of public convenience and necessity accorded them by their "grandfather" rights. While the CAB has allowed the entry of a new class of "local service" carriers, it has not allowed the entry of a single new trunk carrier to compete in the principal markets since 1938. CAB entry protection has been sufficient to enable the grandfather carriers to retain about nine tenths of total domestic air service, despite a 250-fold increase in total traffic since 1938. Since in unregulated industry the absence of effective price competition and excessive prices brings about new entrants, one can see the importance of the foreclosure of entry in discouraging effective competition. While the Board has granted the entry of existing firms into formerly monopoly markets (i.e., between two cities) so that monopoly itself is not a major problem, the fact that each firm faces the same rival in many markets reduces the incidence of competition.

It should be pointed out, as well, that a monopoly is not required for the efficient operation of air transportation. Unlike the generation and distribution of electric power, for example, econometric studies of the airline industry's costs are virtually unanimous in showing the lack of scale economies. That is, in the former case, since electric power can be produced and distributed in a city at less cost by one large firm than four smaller firms, it is in the public interest to establish and regulate a monopoly. This is not the case in the airline industry. While the airlines do not compete with prices, they do compete in other ways, such as advertising and the provision of passenger services and amenities. This form of competition is beneficial to the traveller, and can be most noticed in its absence in those markets with only one carrier or whether there is no effective