How Do Incumbents Respond to the Threat of Entry? Evidence from the Major Airlines
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ARTICLE SUMMARY
This paper shows that airlines lower prices on routes when new competitors may easily enter the market.
POLICY RELEVANCE
This paper provides some evidence of anticompetitive behavior in the airline industry, but its applicability to other markets is uncertain.
KEY TAKEAWAYS
- When a new firm enters a market, firms that were previously active in the market—incumbent firms—typically lower their prices.
- However, some mathematical models predict that incumbent firms should lower their prices before a new firm is able to enter the market in order to discourage its entry. Others models predict no preemptive price changes.
- However, some mathematical models predict that incumbent firms should lower their prices before a new firm is able to enter the market in order to discourage its entry. Others models predict no preemptive price changes.
- This paper examined the pricing behavior of incumbent airlines in markets that Southwest had the potential to enter as it expanded.
- These incumbents cut fares on flights between cities where Southwest could easily establish a route before Southwest actually established a route.
- When Southwest was assured to enter a market, data weakly suggest that incumbent airlines did not cut prices; this supports the hypothesis that preemptive price cuts aim to deter entry by competitors.
- In response to fare reductions, more passengers flew the routes operated by incumbent airlines, but the airlines did not otherwise increase their capacity on those routes.
- These incumbents cut fares on flights between cities where Southwest could easily establish a route before Southwest actually established a route.
- The applicability of these results to other markets is not clear.
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About Austan Goolsbee
Austan D. Goolsbee studies the Internet, the new economy, government policy, and taxes.
He recently returned from Washington where he was the Chairman of the Council of Economic Advisers and a member of the President's cabinet. Before Washington, his research earned him recognition as a Fulbright Scholar and a Sloan fellow. In previous years, he was named one of the Global Leaders for Tomorrow by the World Economic Forum, one of the six "Gurus of the Future" by the Financial Times and one of the "40 under 40" by Crain's Chicago Business.
