Tuesday, November 16, 2010

Product Differentiation

Blog readers may be interested in Cristian Huse & Alessandro V.M. Oliveira's new working paper, Does Product Differentiation Soften Price Reactions to Entry? Evidence from the Airline Industry (Latin American Ctr. for Transp. Econ. Working Paper No. 35, Nov. 12, 2010) (available from SSRN here).  From the abstract:

We examine the effects of entry on the pricing behavior of incumbent legacy airlines in a market where the newcomer is a rapidly expanding low-cost carrier - the Brazilian airline industry in the early 2000s. We estimate the timing and the determinants of price responses to entry allowing them to be asymmetric and controlling for product differentiation. We also propose a decomposition procedure of time fixed-effects to better control for unobserved heterogeneity in prices: by accounting for time-varying route-, city- and carrier-specific unobservables, we find that incumbents do price-respond to actual entry but not to potential entry. We provide suggestive evidence that the lack of preemptive behavior is due to the fact that financially distressed incumbents with virtually no bankruptcy protection were not able to engage in costly deterrence against a newcomer with deep pockets and committed to expansion. Our most important results uncover product differentiation effects stemming from more convenient departures during peak hours and nonstop service, which significantly softened actual price responses.


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