Network Game and Capacity Investment Under Market Uncertainty

Abstract

This paper investigates the impacts of competition and market uncertainty on airlines' network structures and capacity investment. The airlines choose their network structures and construct capacities while demands are unknown. After uncertainty is resolved, they determine the total number of seats to offer in each leg constrained by their capacities built earlier. We conclude that market uncertainty is the driving force of hub‐and‐spoke networks, whereas the market mean is the driving force of point‐to‐point networks. Which of the two countervailing forces dominates determines the equilibrium network structures. Moreover, we find that the airlines' total expected profits in the mixed equilibrium in which the airlines employ different networks are larger than in the pure hub‐and‐spoke network equilibrium in which each airline employs the hub‐and‐spoke network. However, the mixed equilibrium does not necessarily yield larger profits than the pure point‐to‐point equilibrium in which each airline employs the point‐to‐point network.

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