A Model of Dynamic Limit Pricing with an Application to the Airline Industry / Christopher Gedge, James W. Roberts, Andrew Sweeting.

Format:

Book

Author/Creator:

Gedge, Christopher.

Contributor:

National Bureau of Economic Research.

Roberts, James W.

Sweeting, Andrew.

Series:

Working Paper Series (National Bureau of Economic Research) no. w20293.

NBER working paper series no. w20293

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2014.

Summary:

The one-shot nature of most theoretical models of strategic investment, especially those based on asymmetric information, limits our ability to test whether they can fit the data. We develop a dynamic version of the classic Milgrom and Roberts (1982) model of limit pricing, where a monopolist incumbent has incentives to repeatedly signal information about its costs to a potential entrant by setting prices below monopoly levels. The model has a unique Markov Perfect Bayesian Equilibrium under a standard form of refinement, and equilibrium strategies can be computed easily, making it well suited for empirical work. We provide reduced-form evidence that our model can explain why incumbent airlines cut prices when Southwest becomes a potential entrant into airport-pair route markets, and we also calibrate our model to show that it can generate the large price declines that are observed in the data.

Notes:

Print version record

July 2014.