Capacity Investments, Exclusionary Behavior, and Welfare: A Dynamic Model of Competition in the Airline Industry

Abstract

This paper uses unique data on access to airport facilities to study the strategic entry, exit, and capacity decisions of firms in the US airline industry. I estimate a dynamic equilibrium model in which forward-looking firms invest in seating capacity and play a capacity-constrained pricing game. I find that the intensity of competition depends directly on the characteristics and identity of the incumbent fi rm. In particular, dominant hub carriers aggressively invest in capacity following entry by low-cost carriers, providing a commitment to price aggressively in future periods. In doing so, the hub carrier can substantially increase the likelihood of exit by the targeted rm. The resulting reduction in the level of competition reduces consumer welfare relative to an environment in which anti-trust authorities can eliminate such exclusionary behavior.