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

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Presentation on theme: "Everyday Economics: Applications in Aviation and Tourism Michael Fung and Fred Ku Decision Sciences and Managerial Economics, CUHK Business School."— Presentation transcript:

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 Microeconomics in Aviation Macroeconomics in Aviation Environmental Economics in Aviation

5 Part I Microeconomics in Aviation

6 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 747-400: 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. 1998. 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: speaking/aviation-glossary

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: 1. Cathay Pacific Catering Services (HK) Limited – Airline Catering 2. Asia Miles Limited – Loyalty Programme 3. Cathay Pacific Service Limited – Cargo Terminal 4. Hong Kong Airport Services Limited – Aircraft Ramp Handling 5. Vogue Laundry and Cleaning Limited – Laundry and Dry Cleaning 6. 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 Part II Macroeconomics in Aviation

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

32 Additional Reference Materials Airport Authority Hong Kong (2012). Press release at March 20, 2012. Retrieved from releases/pr_1060.html releases/pr_1060.html (with PowerPoint presentations downloadable) 2010 ? 2010 4 15 2011 2011 8 13 2011 2011 9 1 2012 2012 3 1

33 Facts about HKIA 19982010 Passengers28.6m50.9m Cargos1.6m tonnes4.1m tonnes Air Traffic Movements (ATMs)/Day 450850 Number of Destinations 120160 % of transfer/Transit passengers 25%35.1% *m = million Source: HKIA MP 2030 Summary; Annual Reports of HKIA

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

35 Competition AirportNos of Runways Planned number of runways Beijing Capital3Planning to build a 2 nd airport Guangzhou Baiyun25 Shanghai Pudong35 Singapore Changi23 Seoul Incheon35 by 2020 Tokyo Narita23 Shenzhen Baoan23 Source: HKIA MP2030 Summary; various airports websites

36 Reasons for Third Runway Source: HKIA MP2030 Executive Summary

37 Details of the 3 rd Runway The forecasted flight movements at 2030 = 602,000 Current capacity (as at 2010) = 360,000 HKIA under 3-runway system Length of the 3 rd runway3.8 km Design capacity620,000 ATMs per year Construction timeAbout 10 years Construction costsHK$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 Environme ntal permit Foreshore & seabed gazettal Financial ~1 year Project Implementatio n Land reclamation Detailed designs Construction of related facilities Commissioni ng of a 3 rd runway ~8 years Source: HKIAs press release at March 20, 2012

39 Funding Borrowing 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 2012-2061: HK$912 billion (in 2009 dollars) Direct employment: 141,000 jobs by 2030 Indirect + Induced employment: 199,000 by 2030 Construction costs: HK$86.2 billion (in 2010 dollars) / HK$ 136.2 billion (at MOD prices) Source: HKIA Master Plan 2030

41 Costs & Benefits Analysis (i) Enright, Scott & Associates, Ltd (ESA). 2011. Airport Master Plan 2030 Economic Impact Study for the Hong Kong International Airport Available at: ublications/consultancy_reports.html ublications/consultancy_reports.html (ii) Aviation Policy and Research Center (APRC), Chinese University of Hong Kong. 2012. 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 Kongs economy were estimated by subtracting the tourism import impact estimates from the tourism export impact estimates. *This parts information is quote directly from ESAs 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 Regional Input- output Models Economic multipliers are generated Indirect & induced benefits are projected for 2009-2030 Ripple effects on each industry are shown Source: ESAs 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: ESAs 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 2009-2030

48 Total Economic Impact with 3 rd Runway – Value Added Value Added ( HK$ Millions) 2008 2030 Direct BenefitsValue added29,44693,764 Share of GDP1.75% 2.57% Indirect Benefits Value added32,040 42,211 Share of GDP1.91% 1.16% Induced BenefitsValue added16,10131,497 Share of GDP0.96%0.86% Catalytic BenefitsTourismValue added10,272(-12,644) 18,273(-26,269) Share of GDP0.61%(-0.75%)0.50%(-0.72%) TradeValue added61,588 146,555 Share of GDP3.67% 4.02% Catalytic Indirect +Value added107,012257,843 Induced BenefitsShare of GDP6.37%7.07% Overall Value added256,459 590,143 Share of GDP15.27%16.18% GDP 1,679,0003,647,000 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: ESAs Economic Impact Study for HKIA

49 Total Economic Impact with 3 rd Runway – Employment Employment (Persons)2008 2030 Direct Benefits Employment61,604 141,141 % of labor force 1.69% 3.66% Indirect BenefitsEmployment66,45595,416 % of labor force 1.83%2.48% Induced Benefits Employment57,399 104,075 % of labor force 1.58% 2.70% Catalytic BenefitsTourismEmployment32,116(-39,532)62,917(-90,450) % of labor force 0.88%(-1.09%)1.63%(-2.35%) TradeEmployment78,402 218,574 % of labor force 2.16%5.68% Catalytic Indirect + Induced Benefits Employment263,506 645,480 % of labor force 7.24% 16.76% OverallEmployment559,4821,267,603 % of labor force 15.38%32.91% Employment3,637,2003,851,300 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: ESAs 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 Direct Benefits Air Transport & incidental Services Travel agents & Airline ticket agents Courier Services Miscellaneous Services Land Transport

52 Value Added of the Aviation Industry at Current Prices Unit: HK$ million (unless otherwise specified) 20052006200720082009 Direct benefits Air transport and incidental services Value added44,66143,78646,48932,07542,422 Share of GDP 3.29%3.01%2.94%2.01%2.74% (b.p. and curr. p.) Indirect benefits Trade services Value added59,15160,96266,53064,07059,549 Share of GDP 4.35%4.20%4.21%4.02%3.84% (b.p. and curr. p.) Tourism Value added7,9529,3339,9049,9498,026 Share of GDP 0.59%0.64%0.63%0.62%0.52% (b.p. and curr. p.) Logistics Value added6,3636,3306,5996,0476,286 Share of GDP 0.47%0.43%0.42%0.38%0.41% (b.p. and curr. p.) Overall Value added118,127120,411129,523112,141116,283 Share of GDP 8.69%8.29%8.20%7.04%7.50% (b.p. and curr. p.) GDP (b.p. and curr. p.) 1,359,2001,452,8001,580,1001,592,9001,550,900

53 Part III Environmental Economics in Aviation

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

55 Air Pollution Aircraft engine emissions approximately consists of 70% carbon dioxide (CO 2 ) < 30% water vapor (H 2 O) < 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 Emissions at ground level affect health: lung diseases, respiratory diseases,… Emissions at higher altitudes may cause global warming and climate change % of emissions CO 2, H 2 O, NOx, SOx, Particulates VOCs, CO airport ground level operations and Landing & Take-Offs 10%30% higher altitudes90%70% Source: Federal Aviation Administration

57 Quantification of Air Pollution Carbon Tax Australia charges carbon tax at a fixed price of AUD23/tonne of CO 2 for ~500 companies from July, 2012 New Zealand charges NZD25 for 2 tonnes of emission until 31 Dec 2012. Carbon credits can be exchanged in open market afterwards EU Emission Trading Scheme (ETS): Governments issue permits which are tradable privately, OTC or over EUs 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 2004-2006. 2004-2006 average emission 219,476,343 tonnes of CO 2 No of allowances in 2012 97% of 2004-06 average:212,892,052 tonnes of CO 2 No of allowances from 2013 onwards 95% of 2004-06 average: 208,502,525 tonnes of CO 2 Target: Cut 50% carbon by 2030 1 allowance can emit 1 tonne of CO 2 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, childrens 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. 1998. Why do Aircraft Noise Value Estimates Differ?

64 Thank you!

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