Abstract
In the airline industry that has a characteristic of free entry, a firm has to incur setup costs to form airline network, and hence to analyze firm's strategy on network, i.e., the economy of density, is one of the major themes in the analysis of the industry. In this paper, I consider the undercut proof equilibrium (Morgan and Shy, 2000), and check whether the network formation is socially optimal or not.
Suppose that all passengers can travel to their destinations, when only one of the two firms forms network. In this case, if each of two competing firms forms network, increasing density of network may be efficient because of reduction in, for example, time costs of passengers, while it may be inefficient because of double setup costs. I compare market outcome with socially optimal one, and show following results : When market is competitive, there can be excessive network, while when market is monopolistic, there can be inefficient network.
JEL classification : L11, L13, L93, R49.
