Taking Price Dispersion into Account in Demand Estimation: Airline Bankruptcy and Consumer Surplus Change

Price dispersion is large and prevalent in the airline industry, and this can pose a problem in demand and welfare estimation. Usual demand estimation schemes use average prices, ignoring price dispersion. This paper proposes to use the empirical distribution of prices given by data and put a particular restriction on the correlation between price draws across products. The positive correlation between price draws across products arises from potential dynamic and static price discrimination based on consumer heterogeneities in terms of purchase timing, exibility, search ability, etc.. We apply this method to estimate the e¤ect of major, incumbent bankruptcy on consumer welfare: Bankruptcy may be welfare-decreasing if it only reduces competition, whereas it can be welfare-enhancing if it levels the playing \u85elds, boosting competition, or leads bankrupt rms to reorganize operations, improving production e ¢ ciency. In particular, we estimate demand for air travel in the U.S. domestic airline industry and compare consumer surplus before and after the bankruptcies of United Airline and US airways in 2002 and those of Delta and Northwest in 2005, respectively