Spatial Competition in the Airline Industry

Abstract

Airline passengers consider flights departing from airports in different cities to be substitutes and sometimes travel large distances to board a flight with lower fares. While this “airport leakage” phenomenon is a major concern for airport administrators, the industrial organization literature has assumed that flights departing from airports in different cities are in totally separate markets. This assumption rules out these substitution patterns altogether and could yield biased estimates of elasticities and markups. Using an airline passenger survey conducted annually at San Francisco International Airport, I estimate a structural model of air travel demand that allows consumers to choose among flights departing from airports in different cities. I then compare the results from my model to those from the conventional model that defines markets as origin-destination airport pairs. I find that leisure passengers are willing to travel up to 69 miles to save $100 on airfare. As a result, demand is 74 percent more elastic and markups are 41 percent lower when spatial competition is accounted for. These results suggest that airlines face substantial competition from flights departing from nearby airports and that the origin-destination airport pair definition of airline markets overstates market power.