Price competition and inefficiency of free network formation in the airline market

The analyses presented herein use the undercut-proof equilibrium, a new equilibrium concept for price competition with product differentiation, to illustrate whether it is socially optimal for an airline to form a network freely. The results show that an excessive network is formed if the differences, in terms of distance, between two airlines are small. If the differences are moderate, an excessive network is formed depending on the set-up costs and the number of passengers. For large differences, an excessive network is formed based on the set-up costs. (C) 2006 Elsevier Ltd. All rights reserved.