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Dynamic Effect of Low-Cost Entry on the Conduct Parameter: An Early-Stage Analysis of Southwest Airlines and America West Airlines

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  • Hideki Murakami

    (Graduate School of Business Administration, Kobe University)

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    Abstract

    The purpose of this research is to investigate the dynamic changes in the competition between air carriers by applying a revised conduct parameter method. We examined the cases of Southwest Airlines and America West Airlines due to the availability of data. Our interest is in what fashion a low-cost carrier (LCC) entered the market, how the rival reacted, and whether the fashions of competition between two types of air carrier remained stable as time passed. Our empirical results obtained by econometric methods using 894 sample observations show that the fashions of competition fell between Cournot competition and ``P=MC (price equals marginal cost)" competition, and sometimes the fashions were stable and sometimes not. Beyond four or five years after new entry by an LCC, these two fashions of competition reached a state of equilibrium. An implication for industrial policy is that an LCC' s entry improves consumer surplus but it seems not to maximize social welfare.

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    File URL: http://www.b.kobe-u.ac.jp/paper/2012_25.pdf
    File Function: First version, 2012
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    Bibliographic Info

    Paper provided by Kobe University, Graduate School of Business Administration in its series Discussion Papers with number 2012-25.

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    Length: 20 pages
    Date of creation: Jul 2012
    Date of revision:
    Handle: RePEc:kbb:dpaper:2012-25

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    Web page: http://www.b.kobe-u.ac.jp/repec/kbb/
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    Keywords: LCC; new entry; conduct parameter; dynamic analysis;

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    1. Iwata, Gyoichi, 1974. "Measurement of Conjectural Variations in Oligopoly," Econometrica, Econometric Society, Econometric Society, vol. 42(5), pages 947-66, September.
    2. Fu, Xiaowen & Dresner, Martin & Oum, Tae H., 2011. "Effects of transport service differentiation in the US domestic airline market," Transportation Research Part E: Logistics and Transportation Review, Elsevier, Elsevier, vol. 47(3), pages 297-305, May.
    3. Lindh, T., 1988. "The Inconsistency Of Consistent Conjectures: Coming Back To Cournot," Papers, Uppsala - Working Paper Series 1988d, Uppsala - Working Paper Series.
    4. Austan Goolsbee & Chad Syverson, 2008. "How do Incumbents Respond to the Threat of Entry? Evidence from the Major Airlines," The Quarterly Journal of Economics, MIT Press, MIT Press, vol. 123(4), pages 1611-1633, November.
    5. Bresnahan, Timothy F, 1981. "Duopoly Models with Consistent Conjectures," American Economic Review, American Economic Association, American Economic Association, vol. 71(5), pages 934-45, December.
    6. Tae Hoon Oum & Xiaowen Fu & Mark Lijesen, 2005. "An Analysis of Airport Pricing and Regulation in the Presence of Competition Between Full Service Airlines and Low Cost Carriers," CIRJE F-Series, CIRJE, Faculty of Economics, University of Tokyo CIRJE-F-316, CIRJE, Faculty of Economics, University of Tokyo.
    7. Brander, James A. & Zhang, Anming, 1993. "Dynamic oligopoly behaviour in the airline industry," International Journal of Industrial Organization, Elsevier, Elsevier, vol. 11(3), pages 407-435, September.
    8. Karen Clay & Werner Troesken, 2003. "Further Tests of Static Oligopoly Models: Whiskey, 1882-1898," Journal of Industrial Economics, Wiley Blackwell, Wiley Blackwell, vol. 51(2), pages 151-166, 06.
    9. Lau, Lawrence J., 1982. "On identifying the degree of competitiveness from industry price and output data," Economics Letters, Elsevier, Elsevier, vol. 10(1-2), pages 93-99.
    10. Corts, Kenneth S., 1998. "Conduct parameters and the measurement of market power," Journal of Econometrics, Elsevier, Elsevier, vol. 88(2), pages 227-250, November.
    11. James A. Brander & Anming Zhang, 1990. "Market Conduct in the Airline Industry: An Empirical Investigation," RAND Journal of Economics, The RAND Corporation, vol. 21(4), pages 567-583, Winter.
    12. Catherine D. Wolfram, 1999. "Measuring Duopoly Power in the British Electricity Spot Market," American Economic Review, American Economic Association, American Economic Association, vol. 89(4), pages 805-826, September.
    13. Steven Puller, 2009. "Estimation of competitive conduct when firms are efficiently colluding: addressing the Corts critique," Applied Economics Letters, Taylor & Francis Journals, Taylor & Francis Journals, vol. 16(15), pages 1497-1500.
    14. Oliveira, Alessandro V.M. & Huse, Cristian, 2009. "Localized competitive advantage and price reactions to entry: Full-service vs. low-cost airlines in recently liberalized emerging markets," Transportation Research Part E: Logistics and Transportation Review, Elsevier, Elsevier, vol. 45(2), pages 307-320, March.
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