Incumbent responses to low-cost airline entry and exit: A spatial autoregressive panel data analysis

Abstract While the US airline industry has been substantially transformed in recent years by the growth of low-cost airlines, the cost-saving benefits of lower airfares are difficult to gauge empirically. There are two important ways in which this paper contributes to the existing literature on the impact of the low-cost carriers (LCCs). First, the availability of route-level panel data allows us to examine the role of the LCCs in the long-run adjustment of airfares as well as the responses of the incumbent carriers to LCC entry and exit in a dynamic setting. Second, we capitalize on recent developments in spatial econometrics and explicitly model the spatial dependence among adjacent airline routes, an issue often ignored by previous studies. Although most of the pro-competitive effects of LCC entry take place after entry, we find evidence that the incumbent carriers also cut airfares in anticipation of entry by the LCCs. Moreover fares remain lower even after Southwest Airlines exits. Our empirical analysis confirms the spatial dependence among airfares in adjacent routes, provides estimates of the consumer benefits from lower airfares in routes affected by LCCs, and shows that there are substantial indirect benefits, i.e. lower fares in spatially-linked, nearby routes.