Explaining the Effect of Competition on Price Dispersion: Evidence from the US Airline Industry

This paper studies the effect of competition on price dispersion in the airline industry by looking at how a monopolist responds to entrants. Like most studies on price dispersion in the airline industry we differentiate between different sort of entrants (LCCs and legacy carriers) and as an addition to previous literature we specify between different sorts of incumbents. Subsequently, we add another dimension by examining the differences between business and leisure routes. We find a weakly significant increase in the price dispersion of a legacy incumbent when a legacy carrier enters its market and a negative effect when an LCC enters. We find a negative effect of competition on the price dispersion of an incumbent when both incumbent and entrant are LCCs, this effect is even stronger when looking at leisure routes. Furthermore we study a possible convergence in pricing strategies between legacy carriers and LCCs but find no evidence for this.