Demand Uncertainty and Airline Network Morphology with Strategic Interactions

In this paper, we examine how strategic interactions affect airline network. We develop a three stage duopoly game: at stage 1 airlines determines their network structure (linear versus hub-and-spoke). At stage 2 they decide on their capacities, and at stage 3 firms compete in quantities. The main feature of the model is that firms have to decide on network structure and capacities while facing demand uncertainty. We show that while hubbing is efficient, airlines may choose a linear network for strategic reasons. Furthermore, we show that this structure softens competition by preventing contagion of competition across markets.