Dynamic Effect of Low-Cost Entry on the Conduct Parameter: An Early-Stage Analysis of Southwest Airlines and America West Airlines

The purpose of this research is to investigate the dynamic changes in the competition between air carriers by applying a revised conduct parameter method. We examined the cases of Southwest Airlines and America West Airlines due to the availability of data. Our interest is in what fashion a low-cost carrier (LCC) entered the market, how the rival reacted, and whether the fashions of competition between two types of air carrier remained stable as time passed. Our empirical results obtained by econometric methods using 894 sample observations show that the fashions of competition fell between Cournot competition and ``P=MC (price equals marginal cost)" competition, and sometimes the fashions were stable and sometimes not. Beyond four or five years after new entry by an LCC, these two fashions of competition reached a state of equilibrium. An implication for industrial policy is that an LCC' s entry improves consumer surplus but it seems not to maximize social welfare.