A Study Of The Effects Of Korean Airline Deregulation: The Impact Of Low Cost Carriers (Lccs) Entry On Air Travel Demand And Welfare Gains

Field: Economics, Econometrics and Finance (Social Sciences)

This dissertation examines the consequences of the Korean Airline Deregulation Act of May 2008. I propose an empirical methodology for analyzing demand and supply in differentiated product markets that measures welfare effects due to the entry of Low Cost Carriers (LCCs) from two perspectives: pre- and post-deregulation. I have built a panel of airline carrier level data for each of the seven domestic non-stop routes from June 2006 to October 2010 to investigate whether the deregulation policy is desirable for increasing the net welfare gains to air passengers, and for promoting competition among airline carriers. Chapter 1 explains the implementation and effects of the Act change on the Korean airline industry. The Act removed restrictions imposed on both aircraft size and aircraft age for the non-scheduled air service carriers so that all LCCs were able to operate jet aircraft which had more than 100 seats per airplane. Since May 2008, the competition, long dominated by two legacy carriers, Korean Air (KAL) and Asiana Air (AAR), has intensified as emerging LCCs have began offering lower air fares. Chapter 2 outlines the empirical framework of the nested logit model and applies it to two categories of city pair routes in Korea: five Jeju island routes and two inland routes. A priori there are expectations of differences in both types of travelers and in alternatives to air transportation, thus differences in air travel demand sensitivity to price and non-price factors, such as frequent flights and aircraft size. In this chapter, I find evidence of a common sensitivity to price across the Jeju island routes and the inland routes and route-specific response to flight characteristics. Thus, I propose a joint constrained model in terms of price sensitivity where the parameter for price variable is constrained to be the same across all seven routes, but the flight characteristics should be permitted to have route-specific effects. Frequent flights, larger aircraft, evenly distributed flight schedules on peak-demand hours (lunchtime for some routes), and shorter airtime duration generate a higher utility for air passengers. Chapter 3 models the supply side and legacy carriers' strategic responses to the emergence of LCCs. The two legacy carriers established their own subsidiary LCCs (dependent LCCs). KAL entered some routes with its subsidiary LCC, JNA, while AAR rebadged to ABL, its subsidiary LCC, replacing their prior service. Chapter 4 integrates the demand- and supply-side in order to derive average price elasticities for air travel demand, implied marginal costs and Lerner indices for each carrier's flights. Price-cost markups are recovered after the demand parameters are first obtained and then inserted in the pricing equation. The estimated results for a dominant airline carrier on some inland routes are inconsistent with the static profit maximization assumption, having inelastic demand elasticities and negative marginal costs. Chapter 5 contributes to the literature on the spatial competition of the airline industry. Empirical findings using time-series data from June 2006 to October 2010 in this chapter suggest that the effects of competition on the degree of inter-firm departure times differentiation would have a different impact across the Jeju island routes and the inland route in the deregulated period. Chapter 6 evaluates the welfare gains due to the entry of LCCs. I calculate welfare gains from various types of post-deregulation entry behaviors that are driven by the change in market structure. I find a few entries (i.e., none in half the markets) induced by deregulation. The welfare calculations imply that consumer welfare results are mixed and total welfare results have little evidence to support welfare improvement. I find the introduction of fuel surcharge to be the major obstacles hindering benefits from the Act change for aggregate consumers and industry-wide producers at times of unusually high fuel surcharges. Finally, I summarize and discuss some problems with extensions of this approach.