1. Everyday Economics: Applications in Aviation and Tourism
Michael Fung and Fred Ku
Decision Sciences and Managerial Economics,
CUHK Business School

2. Aviation Economics
Michael Ka Yiu Fung Aviation Policy and Research Center, CUHK Business School Air Transport Licensing Authority, HKSAR

3. Aviation Economics

4. Aviation Economics Microeconomics in Aviation
Macroeconomics in Aviation
Environmental Economics in Aviation

5. Microeconomics in Aviation
Part I
Microeconomics in Aviation

6. Microeconomics in Aviation
Aviation Industry: Capital, Technology and Service Intensive Sector
Aviation Industry: Highly Regulated Industry

7. Microeconomics in Aviation
Scale Economies
Scope Economies
Network Economies
Price Discrimination
Vertical/Horizontal Integration
Entry Barrier

8. Scale Economies
The average total cost decreases as the volume of output increases.
Short run or Long run ??
Fixed costs

9. Scale Economies
Hong Kong International Airport: Third Runway Expansion
HK$86.2 Billion (2010 prices)

10. Scale Economies
Airlines: A380
US$390 Million (January, 2012)

11. Scale Economies
Why A380??
A380: 524 (3-class); 644 (2-class); 853 (1-class)
Boeing : 416 (3-class); 524 (2-class); 660 (1-class)
Source: Airbus, Boeing

12. Scope Economies
Lowing average total cost in producing two or more products.
Cost-sharing

13. Scope Economies Hong Kong International Airport:
aeronautical and non-aeronautical activities

14. Scope Economies
Airlines:
passenger and cargo

15. Network Economies
Kelly (1998) states that in a network economy, value is created and shared by all members of a network rather than by individual companies and that economies of scale stem from the size of the network - not the enterprise.
Source: Kelly, Kevin New Rules for the Wired Economy.

16. Network Economies
A hub is a term used to refer to an airport that airlines use frequently for connecting passengers, and cargo. Cargo and travellers moving between airports not served by direct flights use a hub to change planes to get to their destination.
Source:

17. Network Economies Hong Kong International Airport – International Hub
“HKIA is connected to about 160 destinations, including around 40 in the Mainland, through about 900 daily flights by over 100 airlines.”
Source: HKIA

18. Network Economies Cathay Pacific – Hub Carrier
“Over 111 destinations worldwide”
Source: Cathay Pacific

19. Price Discrimination
Price discrimination can exist when three conditions are met: consumers differ in their demands for a given good or service, a firm has market power, and the firm can
prevent or limit arbitrage.

20. Price Discrimination
Airline industry is ideal for price discrimination: The seller has some control on the price, buyers have different price elasticities of demand, and resale of the ticket by the buyer is not possible.

21. Price Discrimination
Yield Management: Software can constantly calculate the empty seats remaining and price them while maximizing returns.

22. Price Discrimination
Airline price discrimination represents an attempt to charge the business traveler more than the leisure traveler, because business travelers typically have less elastic demand.

23. Price Discrimination
By offering different tickets (Saturday night stay-over restrictions, advance purchase discounts, and roundtrip discounts), airlines are attempting to have consumers sort themselves between business and leisure travelers.

24. Price Discrimination
Cathay Pacific: First Class, Business Class Business Standard, Business Flex), Premium Economy Class, Economy Class (Economy Core, Economy Standard, Economy Flex)

25. Vertical Integration
Vertically integrated companies in a supply chain are united through a common owner. Usually each member of the supply chain produces a different product or (market-specific) service, and the products combine to satisfy a common need.
Source: Wikipedia

26. Vertical Integration 100% owned by Cathay Pacific:
Cathay Pacific Catering Services (HK) Limited – Airline Catering
Asia Miles Limited – Loyalty Programme
Cathay Pacific Service Limited – Cargo Terminal
Hong Kong Airport Services Limited – Aircraft Ramp Handling
Vogue Laundry and Cleaning Limited – Laundry and Dry Cleaning
Cathay Holiday Limited – Travel Tour Operator
Source: Cathay Pacific Annual Report 2011

27. Horizontal Integration
Horizontal integration occurs when a firm is being taken over by, or merged with, another firm which is in the same industry and in the same stage of production as the merged firm.

28. Horizontal Integration
100% owned by Cathay Pacific:
Hong Kong Dragon Airlines Limited
Network Economies

29. Entry Barrier Capital Requirement?
Regulatory Requirement: Air Transport License – Bilateral Air Service Agreement, Capital Requirement
Incumbent Advantage: Brand Loyalty, Time Slots

30. Macroeconomics in Aviation
Part II
Macroeconomics in Aviation

31. Related Links - HKIA Master Plan 2030
Executive Summary:
(Chinese) (11 pages)
(English) (11 pages)
Videos:
(Chinese)
(English)

32. Additional Reference Materials
Airport Authority Hong Kong (2012). Press release at March 20, Retrieved from
(with PowerPoint presentations downloadable)
馮嘉耀 2010。「香港機場需要『第三跑道?』」《信報財經新聞 》，2010年4月15日。
馮嘉耀、袁志樂、陳家欣 2011。「本港機場擴建借鑑德國成功經驗」《信報財經新聞》，2011年8月13日。
馮嘉耀、袁志樂、陳家欣 2011。「興建第三跑道─如何達至社會共識﹖」 《信報財經新聞》，2011年9月1日。
馮嘉耀、林艷虹 2012。「香港航空業的經濟貢獻」《信報財經新聞》2012年3月1日。

33. Facts about HKIA 1998 2010 Passengers 28.6m 50.9m Cargos 1.6m tonnes
Air Traffic Movements (ATMs)/Day
450
850
Number of Destinations
120
160
% of transfer/Transit passengers
25%
35.1%
*m = million
Source: HKIA MP 2030 Summary; Annual Reports of HKIA

34. Facts about HKIA (cont’d)
Employment
Current employment on the airport island: ~65,000 people
Value Added
The economic contribution by aviation industry in 2008: HK$ 78 billion1 in value added, or 4.6% of HK GDP
Importance
4 economic pillars2 rely heavily on efficient flow of people and goods
1: Directly cited from the HKIA Master Plan 2030 Summary
2: financial services, trading and logistics, tourism, and producer and professional services

35. Competition Airport Nos of Runways Planned number of runways
Beijing Capital 3
Planning to build a 2nd airport
Guangzhou Baiyun 2 5
Shanghai Pudong
Singapore Changi
Seoul Incheon
5 by 2020
Tokyo Narita
Shenzhen Bao’an
Source: HKIA MP2030 Summary; various airports’ websites

36. Reasons for Third Runway
Source: HKIA MP2030 Executive Summary

37. Details of the 3rd Runway
The forecasted flight movements at 2030 = 602,000
Current capacity (as at 2010) = 360,000
HKIA under 3-runway system
Length of the 3rd runway
3.8 km
Design capacity
620,000 ATMs per year
Construction time
About 10 years
Construction costs
HK$86.2 billion (in 2010 dollars)
Source: HKIA MP2030 Summary

38. Schedule of the Third Runway
Project Planning
Environmental Impact Assessment studies
Associated design details
Funding options
~2 years
Project Approval
Statutory & Govt approvals
Environmental permit
Foreshore & seabed gazettal
Financial
~1 year
Project Implementation
Land reclamation
Detailed designs
Construction of related facilities
Commissioning of a 3rd runway
~8 years
Source: HKIA’s press release at March 20, 2012

39. Funding Borrowing User pays Dividends IPO
Significant borrowing may adversely affect the credit ratings of AAHK
User pays
Significant levy on user fees may adversely affect the air traffic in the future, thus the forecasted traffic volumes and projected revenue become unreliable
Dividends
The withheld dividends still need to pay back the stockholders
IPO
The goal for HKIA would become profit-maximization
Hinder investment on infrastructure which lead to short-term loss in accounts

40. Costs & Benefits
Economic net present value : HK$912 billion (in 2009 dollars)
Direct employment: 141,000 jobs by 2030
Indirect + Induced employment: 199,000 by 2030
Construction costs: HK$86.2 billion (in 2010 dollars) / HK$ billion (at MOD prices)
Source: HKIA Master Plan 2030

41. Costs & Benefits Analysis
(i) Enright, Scott & Associates, Ltd (ESA) Airport Master Plan 2030 Economic Impact Study for the Hong Kong International Airport
Available at:
(ii) Aviation Policy and Research Center (APRC), Chinese University of Hong Kong Economic Contribution of Aviation Industry

42. Economic Impact Study by ESA
Direct
Aviation-related business
Non-aviation-related business at HKIA
Indirect
supplies of goods and services to the activities at the airport
E.g. utilities, fuel suppliers, construction
Induced
Spending of incomes by the direct & indirect employees on local goods & services
Catalytic Direct
Direct contribution of aviation-related tourism & trade
Catalytic Indirect + Induced
Induced contribution of aviation-related tourism & trade

43. Tourism Aviation-facilitated tourism impacts Tourism exports
When calculating the economic impact, consider only outbound tourism
Net tourism*
Net tourism equals tourism exports minus tourism imports minus tourism spending on the airport island
“The net tourism impacts on Hong Kong’s economy were estimated by subtracting the tourism import impact estimates from the tourism export impact estimates.”
*This part’s information is quote directly from ESA’s Economic Impact Study for HKIA.

44. Indirect and Induced Impacts
Economic multipliers are used
provided by Economic Analysis and Business Facilitations Unit, Hong Kong Financial Secretary’s Office

45. Economic Multipliers
Source: ESA’s Economic Impact Study for HKIA

46. Economic Multipliers 2006-2008 – used for projections 2009-2030
Industry
Multiplier
Direct Revenue to Direct + Indirect Value Added Multiplier
Air Transport
0.311
Tourism
0.563
Trade (re-exports)
0.128
Trade (retained imports)
0.111
Induced Value Added to Induced Revenue Multiplier
0.605
Source: ESA’s Economic Impact Study for HKIA

47. Economic Multipliers - Assumptions
Perfect elasticity of supply of inputs
No capacity constraints
No rising salaries and input costs due to the large investment
No technological change from

48. Total Economic Impact with 3rd Runway – Value Added
Value Added ( HK$ Millions)
2008
2030
Direct Benefits
Value added
29,446
93,764
Share of GDP
1.75%
2.57%
Indirect Benefits
32,040
42,211
1.91%
1.16%
Induced Benefits
16,101
31,497
0.96%
0.86%
Catalytic Benefits
Tourism
10,272
(-12,644)
18,273
(-26,269)
0.61%
(-0.75%)
0.50%
(-0.72%)
Trade
61,588
146,555
3.67%
4.02%
Catalytic Indirect +
107,012
257,843
6.37%
7.07%
Overall
256,459
590,143
15.27%
16.18%
GDP
1,679,000
3,647,000
Note: (i) Year 2008 dollar values are in 2008 dollars, the following years are in 2009 dollars.
(ii) The figures in brackets are from net tourism.
Source: ESA’s Economic Impact Study for HKIA

49. Total Economic Impact with 3rd Runway – Employment
Employment (Persons)
2008
2030
Direct Benefits
Employment
61,604
141,141
% of labor force
1.69%
3.66%
Indirect Benefits
66,455
95,416
1.83%
2.48%
Induced Benefits
57,399
104,075
1.58%
2.70%
Catalytic Benefits
Tourism
32,116
(-39,532)
62,917
(-90,450)
0.88%
(-1.09%)
1.63%
(-2.35%)
Trade
78,402
218,574
2.16%
5.68%
Catalytic Indirect + Induced Benefits
263,506
645,480
7.24%
16.76%
Overall
559,482
1,267,603
15.38%
32.91%
3,637,200
3,851,300
Note: (i) Employment in 2030 are obtained from the forecasted 2009 employment in “Hong Kong Labor Force
Projections for 2010 to 2029” issued by the Hong Kong Census and Statistics Department.
(ii) The figures in brackets are from net tourism.
Source: ESA’s Economic Impact Study for HKIA

50. Economic Impact Breakdown
2008 Value added breakdown
(% of GDP)
2030 Value added breakdown
(% of GDP)

51. Economic Contribution by APRC
Miscellaneous Services
Land Transport

52. Value Added of the Aviation Industry at Current Prices
Unit: HK$ million (unless otherwise specified)
2005
2006
2007
2008
2009
Direct benefits
Air transport and incidental services
Value added
44,661
43,786
46,489
32,075
42,422
Share of GDP
3.29%
3.01%
2.94%
2.01%
2.74%
(b.p. and curr. p.)
Indirect benefits
Trade services
59,151
60,962
66,530
64,070
59,549
4.35%
4.20%
4.21%
4.02%
3.84%
Tourism
7,952
9,333
9,904
9,949
8,026
0.59%
0.64%
0.63%
0.62%
0.52%
Logistics
6,363
6,330
6,599
6,047
6,286
0.47%
0.43%
0.42%
0.38%
0.41%
Overall
118,127
120,411
129,523
112,141
116,283
8.69%
8.29%
8.20%
7.04%
7.50%
GDP (b.p. and curr. p.)
1,359,200
1,452,800
1,580,100
1,592,900
1,550,900

53. Environmental Economics in Aviation
Part III
Environmental Economics in Aviation

54. Social Costs – Pollution
Water Quality
Marine Ecology
Fisheries
Air Quality
Noise

55. Air Pollution Aircraft engine emissions approximately consists of
70% carbon dioxide (CO2)
< 30% water vapor (H2O)
< 1% each of
nitrogen oxides (NOx)
carbon monoxide (CO)
oxides of sulfur (SOx)
volatile organic compounds (VOCs)
particulates
Source: Federal Aviation Administration

56. Air Pollution
% of emissions
CO2, H2O, NOx, SOx, Particulates
VOCs , CO
airport ground level operations and Landing & Take-Offs
10%
30%
higher altitudes
90%
70%
Emissions at ground level affect health: lung diseases, respiratory diseases,…
Emissions at higher altitudes may cause global warming and climate change
Source: Federal Aviation Administration

57. Quantification of Air Pollution
Carbon Tax
Australia charges carbon tax at a fixed price of AUD23/tonne of CO2 for ~500 companies from July, 2012
New Zealand charges NZD25 for 2 tonnes of emission until 31 Dec Carbon credits can be exchanged in open market afterwards
EU Emission Trading Scheme (ETS): Governments issue permits which are tradable privately, OTC or over EU’s climate exchanges. Permit price ~ € 10 per tonne on March 2012

58. Quantification of Air Pollution
EU Allowance (EUA): permit to emit one metric tonne of CO2 under EU ETS throughout the period of the contract
National Allocation Plans determine the total quantity of EUAs that Member States grant to their companies, which can then be sold or bought by the companies themselves.
Source: Bloomberg

59. EU ETS – Aviation Q&A 1
How are the aviation emissions allowances determined?
The European Commission (EC) calculates the number of aviation allowances from 2012 based on the average annual aviation emissions by aircraft operators to and from European airports
average emission
219,476,343 tonnes of CO2
No of allowances in 2012
97% of average:212,892,052 tonnes of CO2
No of allowances from 2013 onwards
95% of average: 208,502,525 tonnes of CO2
Target: Cut 50% carbon by 2030
1 allowance can emit 1 tonne of CO2
Source: European Commission

60. EU ETS – Aviation Q&A 2 How are the allowances allocated?
82%: given for free to aircraft operators and
15%: allocated by auctioning
3%: allocated to a special reserve for later distribution to fast growing airlines and new entrants into the market.
Source: European Commission

61. EU ETS – Aviation Q&A 3 How can the allowances be traded?
Private transactions
Market
Currently through the national registry by EU member states
Migrating to the Union Registry which will be fully activated after June 2012
Note: More information about the national registry of each member state,
Please check:

62. Noise Pollution
Causes regional annoyance and interferes with communications, children’s learning, and enjoyment of the outside world.
Health impact: depression, sleep disturbances and hypertension.
Property prices of areas affected by the aircraft noise may decrease in value

63. Quantification of Noise Pollution
To quantify the effects of noise pollution, hedonic pricing is developed
Hedonic pricing
A technique that derives values for non-market goods such as environmental quality using information on the value of market goods such as residential property.
By analyzing a large set of properties that are exposed to varying levels of noise annoyance, while controlling for other relevant characteristics, one can obtain an implicit price for the characteristic peace and quiet.
Reference:Schipper, Nijkamp, Rietveld Why do Aircraft Noise Value Estimates Differ?

64. Thank you!