Network Competition in the Airline Industry: An Empirical Framework

Abstract

This article proposes an empirical framework and a novel equilibrium concept to analyze network competition in the airline industry. A two-stage entry model links direct and indirect flights, using a technological relationship estimated from data to mimic the hub-and-spoke network. It employs revealed-preference arguments to bound fixed cost parameters, estimated using state-of-the-art econometric methods. Ignoring network externality undervalues the benefits of additional flights by 13.2% and leads to 21.5% fewer one-stop flights. A hypothetical merger between Alaska and Virgin in 2014 could increase consumer surplus as the merged airline would offer more flights with muted post-merger prices.