Price Dispersion Under Costly Capacity and Demand Uncertainty

40 Pages Posted: 27 Jun 2007

See all articles by Diego Escobari

Diego Escobari

University of Texas - Pan American - College of Business Administration - Department of Economics & Finance; Texas A&M University - Department of Economics

Li Gan

Texas A&M University - Department of Economics; National Bureau of Economic Research (NBER)

Date Written: May 2007

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

Escobari, Diego and Gan, Li, Price Dispersion Under Costly Capacity and Demand Uncertainty (May 2007). NBER Working Paper No. w13075. Available at SSRN: https://ssrn.com/abstract=986925

Diego Escobari

University of Texas - Pan American - College of Business Administration - Department of Economics & Finance ( email )

1201 W. University Drive
Edinburg, TX 78539-2999
United States

HOME PAGE: http://faculty.utrgv.edu/diego.escobari

Texas A&M University - Department of Economics ( email )

5201 University Blvd.
College Station, TX 77843-4228
United States

Li Gan (Contact Author)

Texas A&M University - Department of Economics ( email )

5201 University Blvd.
College Station, TX 77843-4228
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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