A Dynamic Model of Airline Competition

Abstract

We develop a dynamic model of collusion in airport-pair routes for selected US airlines and specify the first order conditions using a state-space representation that is estimated by Kalman-filtering techniques using the Databank 1A (DB1A) Department of Transportation (DOT) data during the period 1979I-1988IV. We consider two airlines, American (AA) and United (UA) and four city-pairs. Our measure of market power is based on the shadow value of long-run profits in a two-person strategic dynamic game and we find evidence of relative market power of AA in three of the four city pairs we analyze.