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A Dynamic Oligopoly Game of the US Airline Industry: Estimation and Policy Experiments

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Author Info
Victor Aguirregabiria
Chun-Yu Ho

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Abstract

This paper studies the contribution of demand, costs, and strategic factors to the adoption of hub-and-spoke networks in the US airline industry. Our results are based on the estimation of a dynamic oligopoly game of network competition that incorporates three groups of factors which may explain the adoption of hub-and-spoke networks: (1) travelers value the services associated with the scale of operation of an airline in the hub airport (e.g., more convenient check-in and landing facilities); (2) operating costs and entry costs in a route may decline with an airline's scale operation in origin and destination airports (e.g., economies of scale and scope); and (3) a hub-and-spoke network may be an effective strategy to deter the entry of other carriers. We estimate the model using data from the Airline Origin and Destination Survey with information on quantities, prices, and entry and exit decisions for every airline company in the routes between the 55 largest US cities. As a methodological contribution, we propose and apply a simple method to deal with the problem of multiple equilibria when using the estimated model to predict the effects of changes in structural parameters. We find that the most important factor to explain the adoption of hub-and-spoke networks is that the cost of entry in a route declines very importantly with the scale of operation of the airline in the airports of the route. For some of the larger carriers, strategic entry deterrence is the second most important factor to explain hub-and-spoke networks.

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Paper provided by University of Toronto, Department of Economics in its series Working Papers with number tecipa-337.

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Length: 49 pages
Date of creation: 29 Sep 2008
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Handle: RePEc:tor:tecipa:tecipa-337

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Related research
Keywords: Airline industry; Hub-and-spoke networks; Entry costs; Industry dynamics; Estimation of dynamic games; Counterfactuals with multiple equilibria;

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Find related papers by JEL classification:
C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - General
C35 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Discrete Regression and Qualitative Choice Models
C63 - Mathematical and Quantitative Methods - - Mathematical Methods and Programming - - - Computational Techniques
C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General
L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
L93 - Industrial Organization - - Industry Studies: Transportation and Utilities - - - Air Transportation

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
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    Other versions:
  3. Berry, Steven T, 1990. "Airport Presence as Product Differentiation," American Economic Review, American Economic Association, vol. 80(2), pages 394-99, May. [Downloadable!] (restricted)
  4. Kenneth L. Judd, 1985. "Credible Spatial Preemption," RAND Journal of Economics, The RAND Corporation, vol. 16(2), pages 153-166, Summer. [Downloadable!] (restricted)
    Other versions:
  5. Steven Berry & Michael Carnall & Pablo T. Spiller, 1996. "Airline Hubs: Costs, Markups and the Implications of Customer Heterogeneity," NBER Working Papers 5561, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  7. Patrick Bajari & C. Lanier Benkard & Jonathan Levin, 2007. "Estimating Dynamic Models of Imperfect Competition," Econometrica, Econometric Society, vol. 75(5), pages 1331-1370, 09. [Downloadable!] (restricted)
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  8. Ariel Pakes & Michael Ostrovsky & Steve Berry, 2004. "Simple Estimators for the Parameters of Discrete Dynamic Games (with Entry/Exit Examples)," Harvard Institute of Economic Research Working Papers 2036, Harvard - Institute of Economic Research. [Downloadable!]
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  9. Alam, Ila M Semenick & Sickles, Robin C, 2000. "Time Series Analysis of Deregulatory Dynamics and Technical Efficiency: The Case of the U.S. Airline Industry," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 41(1), pages 203-18, February.
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  13. Timothy F. Bresnahan & Peter C. Reiss, 1994. "Measuring the Importance of Sunk Costs," Annales d'Economie et de Statistique, ADRES, issue 34, pages 08, Avril-Jui. [Downloadable!]
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  15. Ulrich Doraszelski & Mark Satterthwaite, 2007. "Computable Markov-Perfect Industry Dynamics: Existence, Purification, and Multiplicity," Levine's Bibliography 321307000000000912, UCLA Department of Economics. [Downloadable!]
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Aguirregabiria, Victor, 2009. "Estimation of Dynamic Discrete Games Using the Nested Pseudo Likelihood Algorithm: Code and Application," MPRA Paper 17329, University Library of Munich, Germany. [Downloadable!]
  2. Michaela Draganska & Sanjog Misra & Victor Aguirregabiria & Pat Bajari & Liran Einav & Paul Ellickson & Dan Horsky & Sridhar Narayanan & Yesim Orhun & Peter Reiss & Katja Seim & Vishal Singh & Raphael, 2008. "Discrete choice models of firms’ strategic decisions," Marketing Letters, Springer, vol. 19(3), pages 399-416, December. [Downloadable!] (restricted)
  3. Hashmi, Aamir Rafique & Van Biesebroeck, Johannes, 2007. "Market Structure and Innovation: A Dynamic Analysis of the Global Automobile Industry," MPRA Paper 1787, University Library of Munich, Germany. [Downloadable!]
  4. Jia Yan & Xiaowen Fu & Tae Oum, 2008. "Exploring Network Effects of Point-to-Point Networks: An Investigation of the Spatial Entry Patterns of Southwest Airlines," Working Papers 2008-21, School of Economic Sciences, Washington State University. [Downloadable!]
  5. Joao Macieira, 2007. "Extending the Frontier: A Structural Model of Investment and Technological Competition in the Supercomputer Industry," Working Papers e07-10, Virginia Polytechnic Institute and State University, Department of Economics. [Downloadable!]
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