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Price Dispersion under Costly Capacity and Demand Uncertainty

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  • Diego Escobari
  • Li Gan

Abstract

This paper tests the empirical importance of the price dispersion predictions of the Prescott-Eden-Dana (PED) models. Equilibrium price dispersion is derived in a setting with costly capacity and demand uncertainty where different fares can be explained by the different selling probabilities. The PED models predict that a lower selling probability leads to a higher price. Moreover, this effect is larger in more competitive markets. Despite its applications to several important market phenomena, there exists little empirical evidence supporting the PED models, mostly because of the difficulty of coming up with an appropriate measure of the selling probabilities. Using a unique panel of U.S. airline fares and seat inventories, we find evidence that strongly supports both predictions of the models. After controlling for the effect of aggregate demand uncertainty on fares, we also obtain evidence of second degree price discrimination in the form of advance-purchase discounts.

Suggested Citation

  • Diego Escobari & Li Gan, 2007. "Price Dispersion under Costly Capacity and Demand Uncertainty," NBER Working Papers 13075, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:13075
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    Cited by:

    1. Escobari, Diego & Jindapon, Paan, 2014. "Price discrimination through refund contracts in airlines," International Journal of Industrial Organization, Elsevier, vol. 34(C), pages 1-8.
    2. James D. Dana Jr. & Eugene Orlov Jr., 2014. "Internet Penetration and Capacity Utilization in the US Airline Industry," American Economic Journal: Microeconomics, American Economic Association, vol. 6(4), pages 106-137, November.
    3. Diego Escobari & Jim Lee, 2014. "Demand uncertainty and capacity utilization in airlines," Empirical Economics, Springer, vol. 47(1), pages 1-19, August.
    4. Raymond Deneckere & James Peck, 2012. "Dynamic Competition With Random Demand and Costless Search: A Theory of Price Posting," Econometrica, Econometric Society, vol. 80(3), pages 1185-1247, May.
    5. Benjamin Eden, 2018. "Price Dispersion And Demand Uncertainty: Evidence From U.S. Scanner Data," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 59(3), pages 1035-1075, August.
    6. Escobari, Diego, 2009. "Systematic peak-load pricing, congestion premia and demand diverting: Empirical evidence," Economics Letters, Elsevier, vol. 103(1), pages 59-61, April.
    7. Diego Escobari, 2013. "Asymmetric Price Adjustments in Airlines," Managerial and Decision Economics, John Wiley & Sons, Ltd., vol. 34(2), pages 74-85, March.
    8. Escobari, Diego, 2009. "Systematic peak-load pricing, congestion premia and demand diverting: Empirical evidence from airlines," EconStor Open Access Articles, ZBW - German National Library of Economics, pages 59-61.
    9. Bilotkach, Volodymyr & Gaggero, Alberto A. & Piga, Claudio A., 2015. "Airline pricing under different market conditions: Evidence from European Low-Cost Carriers," Tourism Management, Elsevier, vol. 47(C), pages 152-163.
    10. Benjamin Eden, 2014. "Demand uncertainty and efficiency," Vanderbilt University Department of Economics Working Papers 14-00011, Vanderbilt University Department of Economics.
    11. Diego Escobari, 2012. "Dynamic Pricing, Advance Sales and Aggregate Demand Learning in Airlines," Journal of Industrial Economics, Wiley Blackwell, vol. 60(4), pages 697-724, December.
    12. Dutta, Goutam & Santra, Sumitro, 2015. "Price Movements of the Competing Airlines in the Indian Market: An Empirical Study (A)," IIMA Working Papers WP2015-01-02, Indian Institute of Management Ahmedabad, Research and Publication Department.
    13. Marco Alderighi & Marcella Nicolini & Claudio A. Piga, 2012. "Combined Effects of Load Factors and Booking Time on Fares: Insights from the Yield Management of a Low-Cost Airline," Quaderni di Dipartimento 171, University of Pavia, Department of Economics and Quantitative Methods.
    14. Andrew Sweeting, 2008. "Equilibrium Price Dynamics in Perishable Goods Markets: The Case of Secondary Markets for Major League Baseball Tickets," NBER Working Papers 14505, National Bureau of Economic Research, Inc.
    15. Adler, Nicole & Mantin, Benny, 2015. "Government and company contracts: The effect on service and prices in international airline markets," Economics of Transportation, Elsevier, vol. 4(3), pages 166-177.
    16. Alfaro Navarro, José-Luis & Andrés Martínez, María-Encarnación & Trinquecoste, Jean-François, 2015. "The effect of the economic crisis on the behaviour of airline ticket prices. A case-study analysis of the New York–Madrid route," Journal of Air Transport Management, Elsevier, vol. 47(C), pages 48-53.
    17. Marco Alderighi & Alessandro Cento & Peter Nijkamp & Piet Rietveld, 2011. "Second-degree Price Discrimination and Inter-group Effects in Airline Routes between European Cities," Tinbergen Institute Discussion Papers 11-118/3, Tinbergen Institute.
    18. Volodymyr Bilotkach & Nicholas G. Rupp & Vivek Pai, 2013. "Value of a Platform to a Seller: Case of American Airlines and Online Travel Agencies," Working Papers 13-08, NET Institute.
    19. Varella, Rafael R. & Frazão, Jessica & Oliveira, Alessandro V.M., 2017. "Dynamic pricing and market segmentation responses to low-cost carrier entry," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 98(C), pages 151-170.
    20. Arnold, Michael A. & Saliba, Christine, 2011. "Asymmetric capacity constraints and equilibrium price dispersion," Economics Letters, Elsevier, vol. 111(2), pages 158-160, May.
    21. Steven L. Puller & Anirban Sengupta & Steven N. Wiggins, 2009. "Testing Theories of Scarcity Pricing in the Airline Industry," NBER Working Papers 15555, National Bureau of Economic Research, Inc.
    22. Alderighi, Marco, 2010. "Fare dispersions in airline markets: A quantitative assessment of theoretical explanations," Journal of Air Transport Management, Elsevier, vol. 16(3), pages 144-150.
    23. Mantin, Benny & Koo, Bonwoo, 2009. "Dynamic price dispersion in airline markets," Transportation Research Part E: Logistics and Transportation Review, Elsevier, vol. 45(6), pages 1020-1029, November.

    More about this item

    JEL classification:

    • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
    • L11 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Production, Pricing, and Market Structure; Size Distribution of Firms

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