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Multiple Equilibria and Deterrence in Airline Markets

Ciliberto, Federico and Zhang, Zhou (2014): Multiple Equilibria and Deterrence in Airline Markets.

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Abstract

We use data from the US airline industry to estimate a model of entry deterrence. We model the interaction among airlines as a repeated static game, where we allow for a very general form of heterogeneity. We consider a menu of three alternative games that describe the strategic interaction among airlines: simultaneous and sequential move games, and a sequential move game with deterrence investments. Following Bernheim [1984], deterrence investments include all investment that raises barriers to entry, and for which the incumbent must incur some investment costs. We show that the profits that incumbents can make in the sequential game, both with and without deterrence investments, are larger than those that they can make if the game is played simultaneously. Thus, we find that on average it is profitable for all firms to deter new entrants, with the exception of United Airlines. Remarkably, United Airlines was under bankruptcy protection during the period of analysis, suggesting that its deterrence investments were not credible. Overall, we find that the data is explained better by a model where firms make deterrence investments. Thus, we cannot reject the hypothesis that incumbents deter entrants in the airline industry.

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