EMPIRICAL ESSAYS ON THE US AIRLINE INDUSTRY A Dissertation by JINKOOK LEE Submitted

145 Pages·2014·1.22 MB·English

EMPIRICAL ESSAYS ON THE U.S. AIRLINE INDUSTRY
A Dissertation
by
JINKOOK LEE
Submitted to the Office of Graduate and Professional Studies of
Texas A&M University
in partial fulfillment of the requirements for the degree of
DOCTOR OF PHILOSOPHY
Chair of Committee, Steven Wiggins
Committee Members, Steven Puller
Stephanie Houghton
Ramkumar Janakiraman
Head of Department, Timothy Gronberg
May 2014
Major Subject: Economics
Copyright 2014 Jinkook Lee
ABSTRACT
This dissertation studies the effects of firm’s collaborative strategy on both demand
and supply, and equilibrium to derive various welfare implications. I explain both
horizontal mergers and vertical relationships, focusing on the U.S. airline industry.
In the first study, I address significant limitations of traditional merger sim-
ulations which have focused solely on price changes while constraining the set of
product characteristics to be identical pre- and post-merger. To overcome the limita-
tions, I endogenize both prices and product characteristics by specifying a two-stage
oligopoly game. After estimating demand and supply system, I simulate the effect
of the Delta and Northwest Airlines merger on prices, product characteristics, and
welfare. The simulation results show that the merged firm tends to increase prod-
uct differentiation post-merger, the higher product differentiation reduces the firm’s
incentive to raise prices, and the changes in characteristics and prices increase not
only the merged firm’s profit but also consumer welfare. I also compare the predicted
to actual post-merger outcome and find that endogenizing product characteristics is
essential to better predict the actual outcome.
The second study investigates the impact of contractual agreements regarding
gates between airports and carriers on major carrier’s market power. Competition
Plans reported by thirty one hub airports provide information on a carrier’s gate-
occupancy, sublease agreement, and Majority-In-Interest clauses at an airport. I
estimate the effects of these contractual practices on passengers’ utility and carriers’
marginal costs. The main results show that a carrier’s gate dominance has a positive
effect on the demand side through passengers’ utility, and business travelers have a
higher willingness to pay for gates than tourists. On the supply side, a carrier’s gate
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dominance decreases its own marginal cost, especially when the airport is congested.
Furthermore, the existence of sublease agreement at an airport is likely to increase
non-signatory carriers’ marginal costs, whereas the provision of Majority-In-Interest
clausesincreasessignatorycarriers’marginalcosts. Basedontheestimates, Iexecute
a counterfactual analysis and find that regulatory limits on gate occupancy can
reduce the differentials in costs and profits between signatory and non-signatory
airlines.
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DEDICATION
To my mother, Sujin, and Junwon
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ACKNOWLEDGMENTS
I would like to express my special appreciation to my advisor, Dr. Steven Wiggins.
Youhavebeenatremendousmentorforme. Iwouldliketothankyouforencouraging
my research and for allowing me to grow as an economist. Your advice on both
research as well as on my career have been priceless. I would also like to thank
Dr. Steven Puller, Dr. Stephanie Houghton, and Dr. Ramkumar Janakiraman for
serving as my committee members even at hardship. I appreciate for letting my
defense be an enjoyable moment, and for your brilliant comments and suggestions.
I would like to give special thanks to my family as well. Words cannot express
how grateful I am to my mother, Myungsoo Kim. Your whole life has motivated me
to make a ceaseless effort. I would also like to thank my parents-in-law, Jichul Shin
and Youngae Pan. You have always supported and encouraged me with best wishes.
A very special thanks goes out to Dr. Tae-seung Kim, without whose motivation
and help I would not have considered a graduate career in economics research. Dr.
Tae-seung Kim is one professor/teacher in my master program. You truly made a
difference in my life, providing me with direction and priceless support. You are
more of a mentor than a professor.
AttheendIwouldlikeexpressappreciationtomybelovedwife,Sujinandourson,
David Junwon Lee, without whose love, I would not have finished this dissertation.
I love you.
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TABLE OF CONTENTS
CHAPTER Page
I INTRODUCTION ············································ 1
II ENDOGENOUS PRODUCT CHARACTERISTICS IN MERGER
SIMULATION: A STUDY OF THE U.S. AIRLINE INDUSTRY 5
II.1 Introduction ··········································· 5
II.2 The Model ············································ 12
II.2.1 Demand ········································· 12
II.2.2 Supply ·········································· 16
II.2.3 Necessary Equilibrium Conditions ················ 20
II.3 Data ·················································· 22
II.3.1 Sources ·········································· 22
II.3.2 Sample Selection and Description ················· 23
II.4 Estimation ············································ 25
II.4.1 Instruments ····································· 27
II.4.2 Estimation Results ······························· 29
II.5 Merger Simulations ···································· 34
II.5.1 Simulation Methodology ························· 35
II.5.2 Simulation Results ······························· 37
II.5.3 Welfare Analysis ································· 43
II.5.4 Comparison between Simulation Result and Actual
Post-merger Outcome ···························· 47
II.6 Conclusion ············································ 49
III AIRPORT-AIRLINE VERTICAL CONTRACT AND MARKET
POWER IN THE U.S. AIRLINE INDUSTRY ·················· 51
III.1 Introduction ·········································· 51
III.2 Contractual Practices between Signatory Airlines and
Airports ············································· 54
III.2.1 Gate Use-and-Lease Agreements ················· 54
III.2.2 Sublease Agreement ····························· 56
III.2.3 Majority-In-Interest Clauses ······················ 57
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CHAPTER Page
III.3 Data and Variable Construction ······················· 58
III.3.1 Competition Plan Data ························· 58
III.3.2 Airline Data ···································· 60
III.4 The Model ··········································· 64
III.4.1 Demand ········································ 64
III.4.2 Supply ········································· 68
III.5 Empirical Model ······································ 70
III.5.1 Method of Estimation ··························· 70
III.5.2 Instruments and Identification ··················· 71
III.6 Result ··············································· 72
III.6.1 Reduced Form Pricing Equation ················· 72
III.6.2 Structural Analysis ····························· 74
III.6.3 Marginal Cost and Profit Estimates ·············· 81
III.6.4 Counterfactual Analysis ························· 83
III.7 Conclusion ··········································· 86
IV CONCLUSION ··············································· 88
REFERENCES ·························································· 91
APPENDIX ····························································· 97
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LIST OF TABLES
TABLE Page
1 Data Sources ·················································· 97
2 Variable Definitions and Summary Statistics for the Estimation
Sample ························································ 98
3 Instrumental Variables for Endogenous Product Characteristics ·· 99
4 Estimation Results on Model Parameters ························ 100
5 Operating Cost per Available Seat Mile ························· 101
6 Description of Simulation Sample ······························· 102
7 Changes in Price and Characteristics of Merged Firm’s Products
in Oligopoly Markets ··········································· 103
8 Changes in Price and Characteristics of Merged Firm’s Products
in Monopoly Markets ·········································· 105
9 Change in Consumer Surplus after the Delta and Northwest Air-
lines Merger ··················································· 107
10 Change in Producer Surplus after the Delta and Northwest Air-
lines Merger ··················································· 108
11 Change in Total Surplus after the Delta and Northwest Airlines
Merger ························································ 109
12 Market Competitiveness of QI and QD markets Pre-merger ······ 110
13 Comparison of Average Market Frequency ······················· 110
14 Number of Consumers who Purchase Merged Firm’s Products ··· 111
15 Variable Definitions and Summary Statistics ···················· 112
16 Terminal Rental Rates and Landing Fees ························ 113
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TABLE Page
17 Tenant and Sub-tenant Relationships at Dallas-Fort Worth Airport 113
18 Summary of Gate Agreement, Sublease Agreement, and MII Clau-
ses at Thirty One Airports ····································· 114
19 Contractual Practices at San Francisco International Airport ····· 115
20 Estimation Results on Model Parameters in Reduced-form Pricing
Equation ······················································ 116
21 Estimation Results on Model Parameters in Structural Model ···· 117
22 Structural Model with Airport Congestion Measure ·············· 118
23 Hub Specifications ············································· 119
24 Robustness Check ·············································· 120
25 Elasticity Estimates on Price and Gate ························· 122
26 Predicted Marginal Cost and Profits for Base Case at Congested
Airports ······················································· 123
27 Predicted Marginal Cost and Profits for Base Case at Highly Con-
gested Airports ················································ 124
28 Number of Airports and Carriers Affected by Counterfactual
Scenarios ······················································ 125
29 Counterfactual Analysis with Reduction in Exclusive Gates at
Congested Airports ············································ 126
30 Counterfactual Analysis with Reduction in Exclusive Gates at
Highly Congested Airports ····································· 127
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LIST OF FIGURES
FIGURE Page
1 An Illustration of Market and Product ·························· 128
2 Operating Cost per Available Seat Mile ························· 128
3 Simulation Design for Decomposing Sources of Price Change ····· 129
4 Measures for the Extent of Product Differentiation ··············· 129
5 Quality Changes of Merged Firm’s Products in All Markets ······ 130
6 Quality Changes of Merged Firm’s Products in Oligopoly Markets 131
7 Quality Changes of Merged Firm’s Products in Monopoly Markets 132
8 Distribution of Market Frequency in QI and QD Markets ········· 133
9 Distribution of Market Frequency in All Markets ················ 134
10 Total Gates and Exclusive or Preferential Gates ················· 135
11 Fare and Product Share ········································ 135
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