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

Victor Aguirregabiria () and Chun-Yu Ho ()

Working Papers from University of Toronto, Department of Economics

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.

Keywords: Airline industry; Hub-and-spoke networks; Entry costs; Industry dynamics; Estimation of dynamic games; Counterfactuals with multiple equilibria (search for similar items in EconPapers)
JEL-codes: C10 C35 C63 C73 L10 L13 L93 (search for similar items in EconPapers)
Pages: 49 pages
Date: 2008-09-29
New Economics Papers: this item is included in nep-com, nep-cse, nep-gth, nep-ind, nep-mic, nep-net and nep-ure
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Related works:
Journal Article: A dynamic oligopoly game of the US airline industry: Estimation and policy experiments (2012) Downloads
Working Paper: A Dynamic Oligopoly Game of the US Airline Industry: Estimation and Policy Experiments (2009) Downloads
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