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.