A Model of Dynamic Limit Pricing with an Application to the Airline Industry

Christopher Gedge, James W. Roberts, Andrew Sweeting

NBER Working Paper No. 20293
Issued in July 2014
NBER Program(s):   IO

The one-shot nature of most theoretical models of strategic investment, especially those based on asymmetric information, limits our ability to test whether they can fit the data. We develop a dynamic version of the classic Milgrom and Roberts (1982) model of limit pricing, where a monopolist incumbent has incentives to repeatedly signal information about its costs to a potential entrant by setting prices below monopoly levels. The model has a unique Markov Perfect Bayesian Equilibrium under a standard form of refinement, and equilibrium strategies can be computed easily, making it well suited for empirical work. We provide reduced-form evidence that our model can explain why incumbent airlines cut prices when Southwest becomes a potential entrant into airport-pair route markets, and we also calibrate our model to show that it can generate the large price declines that are observed in the data.

You may purchase this paper on-line in .pdf format from ($5) for electronic delivery.

Access to NBER Papers

You are eligible for a free download if you are a subscriber, a corporate associate of the NBER, a journalist, an employee of the U.S. federal government with a ".GOV" domain name, or a resident of nearly any developing country or transition economy.

If you usually get free papers at work/university but do not at home, you can either connect to your work VPN or proxy (if any) or elect to have a link to the paper emailed to your work email address below. The email address must be connected to a subscribing college, university, or other subscribing institution. Gmail and other free email addresses will not have access.


Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w20293

Users who downloaded this paper also downloaded* these:
Drake, Starr-McCluer, and McGuire w20292 Do "Reverse Payment" Settlements of Brand-Generic Patent Disputes in the Pharmaceutical Industry Constitute an Anticompetitive Pay for Delay?
Glaeser, Gottlieb, and Ziv w20291 Unhappy Cities
Berry and Barwick w14503 Tracing the Woes: An Empirical Analysis of the Airline Industry
Roberts and Sweeting w16650 Bailouts and the Preservation of Competition
Dinerstein, Einav, Levin, and Sundaresan w20415 Consumer Price Search and Platform Design in Internet Commerce
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us