Entry, Contestability, and Deregulated Airline Markets : An Event Study Analysis of People Express

A number of recent papers have studied the relationship between price and market structure in the deregulated airline industry through a cross-sectional analysis of city-pair markets. Yet, while interesting, several potential difficulties underlie the inferences drawn in these analyses. In this paper, we consider an alternative approach that uses stock price reactions to entry announcements to shed light on the nature of competitive behavior in this industry. The analysis sheds light on three issues. First, it offers a clean test of contestable market theory. Second, it provides evidence on the level of profits or sunk costs present in these markets. Third, it sheds light on the degree of competitive "localization" existing in the industry. The particular entry events that we focus on are those involving People Express Airline in 1984 and 1985. To provide a more complete picture of the effects of these entry events, we also examine the price and quantity changes that occurred following entry