AN EMPIRICAL INVESTIGATION OF DYNAMIC LIMIT PRICING AND CONTESTABLE MARKETS IN THE DEREGULATED AIRLINE INDUSTRY

This dissertation investigates models of dynamic limit pricing and contestable markets in the deregulated airline industry in ninety-two heavily traveled markets during six consecutive quarters of 1980 and 1981. A three equation model describes the pricing behavior of incumbent firms, the entry behavior of potential entrants, and the determination of the equilibrium number of firms. The model is estimated with both pooled and quarterly data using ordinary and three stage least squares regression techniques. The estimation results are consistent with the pricing behavior predicted by models of dynamic limit pricing; markups are higher where impediments to entry limit the force of potential competition. The evidence supports the notion underlying models of strategic entry deterrence and the theory of contestable markets that incumbent firms have some cognition of the threat of rival entry and may respond to this threat by behaving so as to deter entry. But despite the apparent restraining force of potential competition on the pricing behavior of incumbent carriers, potential competition does not appear to be sufficiently strong to force incumbent firms to charge competitive prices. The evidence suggests that impediments to the free entry and exit of airline city-pair markets do exist and are a source of market power for incumbent firms.