Product differentiation and network optimality

Abstract

This paper studies airline network optimality. We modify existing models (Brueckner and Spiller (1991) and Zhang (1996)) to explain airline network optimality, using heterogeneity and different market sizes. Dropping small destinations from a hub-spoke network may increase overall profits and total welfare. But consumer surplus is always higher with a full network. This leads to a policy dilemma: the airline may want to drop smaller destinations, while the local economy benefits from these destinations. The level of substitution hardly has an effect.