Dynamic effect of inter-firm rivalry on airfares: Case of Japan's full-service and new air carriers

•We analyze the dynamic changes in carriers' airfares and outputs after the entrance of four new Japanese carriers.•We use unbalanced panel data of 222 route-and-carrier-specific sample observations.•The theoretical model proposes that full service airlines can increase their output if they provide a differentiated service.•We find that the border of market separation was ambiguous for JAL while ANA provided a differentiated service.•New entrants seemingly improved consumers' surplus of large markets.

This paper analyzes the dynamic changes in carriers' airfares and outputs and computes the change in the consumers' surplus year by year after new Japanese carriers entered thriving routes and started to compete with Japanese full-service airlines. Using unbalanced panel data from 222 routes and carrier specific sample observations, it finds that new carriers discounted airfares significantly as soon as they entered new markets, but two early carriers, Skymark Airlines and AIRDO, which had entered with very low airfares, raised their prices year by year. On the other hand, both All Nippon Airways and Japan Airlines responded to the new entrants and lowered their airfares to a much lesser extent than the new entrants did, and their airfare levels remained almost unchanged for at least four years after the first entry. The consumers' surplus increased significantly in the first year of each new entry but gradually decreased as the new entrants raised their airfares.