A Dynamic Oligopoly Game of the US Airline Industry: Estimation and Policy Experiments
48 Pages Posted: 2 Oct 2008 Last revised: 30 Oct 2016
Date Written: May 1, 2012
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 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 methodological contributions of the paper, we propose and apply a method to reduce the dimension of the state space in dynamic games, and a procedure to deal with the problem of multiple equilibria when implementing counterfactual experiments. Our empirical results show that the most important factor to explain the adoption of hub-and-spoke networks is that the sunk cost of entry in a route declines importantly with the number of cities that the airline connects from the origin and destination airports of the route. For some carriers, the entry deterrence motive 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, Counterfactual experiments in models with multiple equilibria
JEL Classification: C10, C35, C63, C73, L10, L13, L93
Suggested Citation: Suggested Citation