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Demand Uncertainty and Capacity Utilization in Airlines

  • Escobari, Diego
  • Lee, Jim

This paper studies the relationship between demand uncertainty—the key source of excess capacity—and capacity utilization in the U.S. airline industry. We present a simple theoretical model that predicts that lower demand realizations are associated with higher demand volatility. This prediction is strongly supported by the results of estimating a panel GARCH framework that pools unique data on capacity utilization across different flights and over various departure dates. A one unit increase in the standard deviation of unexpected demand decreases capacity utilization by 21 percentage points. The estimation controls for unobserved time-invariant specific characteristics as well as for systematic demand fluctuations.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 46059.

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Date of creation: Feb 2013
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Handle: RePEc:pra:mprapa:46059
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  1. Escobari, Diego, 2009. "Systematic peak-load pricing, congestion premia and demand diverting: Empirical evidence," MPRA Paper 34857, University Library of Munich, Germany.
  2. Nelson, Randy A, 1989. "On the Measurement of Capacity Utilization," Journal of Industrial Economics, Wiley Blackwell, vol. 37(3), pages 273-86, March.
  3. Steven Berry & Panle Jia, 2008. "Tracing the Woes: An Empirical Analysis of the Airline Industry," NBER Working Papers 14503, National Bureau of Economic Research, Inc.
  4. Thomas N. Hubbard, 2003. "Information, Decisions, and Productivity: On-Board Computers and Capacity Utilization in Trucking," American Economic Review, American Economic Association, vol. 93(4), pages 1328-1353, September.
  5. Eden, Benjamin, 1990. "Marginal Cost Pricing When Spot Markets Are Complete," Journal of Political Economy, University of Chicago Press, vol. 98(6), pages 1293-1306, December.
  6. 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.
  7. Engle, Robert F & Lilien, David M & Robins, Russell P, 1987. "Estimating Time Varying Risk Premia in the Term Structure: The Arch-M Model," Econometrica, Econometric Society, vol. 55(2), pages 391-407, March.
  8. Gregory K. Bell & José M. Campa, 1997. "Irreversible Investments And Volatile Markets: A Study Of The Chemical Processing Industry," The Review of Economics and Statistics, MIT Press, vol. 79(1), pages 79-87, February.
  9. Escobari, Diego, 2012. "Asymmetric Price Adjustments in Airlines," MPRA Paper 42115, University Library of Munich, Germany.
  10. Prescott, Edward C, 1975. "Efficiency of the Natural Rate," Journal of Political Economy, University of Chicago Press, vol. 83(6), pages 1229-36, December.
  11. Diego Escobari & Li Gan, 2007. "Price Dispersion under Costly Capacity and Demand Uncertainty," NBER Working Papers 13075, National Bureau of Economic Research, Inc.
  12. James D. Dana & Jr., 1998. "Advance-Purchase Discounts and Price Discrimination in Competitive Markets," Journal of Political Economy, University of Chicago Press, vol. 106(2), pages 395-422, April.
  13. James D. Dana Jr., 1999. "Equilibrium Price Dispersion Under Demand Uncertainty: The Roles of Costly Capacity and Market Structure," RAND Journal of Economics, The RAND Corporation, vol. 30(4), pages 632-660, Winter.
  14. Volodymyr Bilotkach & Yuriy Gorodnichenko & Oleksandr Talavera & Igor Zubenko, 2006. "Are Airlines' Price-Setting Strategies Different?," Discussion Papers of DIW Berlin 645, DIW Berlin, German Institute for Economic Research.
  15. Diego Escobari & Sang-Yeob Lee, 2012. "Demand shifting across flights and airports in a spatial competition model," Letters in Spatial and Resource Sciences, Springer, vol. 5(3), pages 175-183, October.
  16. Volodymyr Bilotkach & Alberto A. Gaggero & Claudio A. Piga, 2011. "Airline Pricing under Different Market Conditions: Evidence from European Low-Cost Carriers," Working Paper Series 47_11, The Rimini Centre for Economic Analysis.
  17. Marco Alderighi, 2010. "The Role of Fences in Oligopolistic Airline Markets," Journal of Transport Economics and Policy, London School of Economics and University of Bath, vol. 44(2), pages 189-206, May.
  18. Wooldridge, Jeffrey M., 1999. "Distribution-free estimation of some nonlinear panel data models," Journal of Econometrics, Elsevier, vol. 90(1), pages 77-97, May.
  19. Kutlu, Levent, 2012. "Price discrimination in Cournot competition," Economics Letters, Elsevier, vol. 117(3), pages 540-543.
  20. Carlton, Dennis W, 1977. "Peak Load Pricing with Stochastic Demand," American Economic Review, American Economic Association, vol. 67(5), pages 1006-10, December.
  21. Jean J. Gabszewicz & Sougata Poddar, 1997. "Demand fluctuations and capacity utilization under duopoly," Economic Theory, Springer, vol. 10(1), pages 131-146.
  22. 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.
  23. H. Kim, 1999. "Economic Capacity Utilization and its Determinants: Theory and Evidence," Review of Industrial Organization, Springer, vol. 15(4), pages 321-339, December.
  24. Pindyck, Robert S., 1986. "Irreversible investment, capacity choice, and the value of the firm," Working papers 1802-86., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  25. Martin Gaynor & Gerard F. Anderson, 1993. "Uncertain Demand, The Structure of Hospital Costs, and the Cost of EmptyHospital Beds," NBER Working Papers 4460, National Bureau of Economic Research, Inc.
  26. Hazledine, Tim, 2010. "Oligopoly price discrimination with many prices," Economics Letters, Elsevier, vol. 109(3), pages 150-153, December.
  27. Severin Borenstein & Nancy L. Rose, 2007. "How Airline Markets Work...Or Do They? Regulatory Reform in the Airline Industry," NBER Working Papers 13452, National Bureau of Economic Research, Inc.
  28. Shapiro, Matthew D, 1993. "Cyclical Productivity and the Workweek of Capital," American Economic Review, American Economic Association, vol. 83(2), pages 229-33, May.
  29. Brown, Gardner, Jr & Johnson, M Bruce, 1969. "Public Utility Pricing and Output under Risk," American Economic Review, American Economic Association, vol. 59(1), pages 119-28, March.
  30. 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, 05.
  31. Lee, Jim, 2010. "The link between output growth and volatility: Evidence from a GARCH model with panel data," Economics Letters, Elsevier, vol. 106(2), pages 143-145, February.
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