Presentation on theme: "Airplanes Sierra Prochna, Elise Lepe, Louis Hwang, Evanka Weerasinghe, and Stephanie Wilson Louis: Our group did our presentation on airplanes in the economy."— Presentation transcript:
1AirplanesSierra Prochna, Elise Lepe, Louis Hwang, Evanka Weerasinghe, and Stephanie WilsonLouis: Our group did our presentation on airplanes in the economy. We looked at aspects in the airport industry such as Competition and Landing Fee Emergence, Price Cap Regulation of Airports, Airplanes and Comprative Advantage, and the Southwest Effect.
2Competition and Landing Fee Emergence Sierra: Airports make money numerous ways. One way is by charging airlines to land.
3Airline competition 20 years ago Most airports were public sector owned (gov’t)Regulation/specific agreements held landing fees to nonprofit levels (couldn’t bargain/change)Competition between airports didn’t existSierra: This means they were all owned by the government.Airlines can bargain or change prices that the airports were charging for landing.
4Changes nowMarket structure: low cost airlines have brought new, often non-central airports, into effective competitionPrivatization: 55 countries have partially or totally privatized their airportsRegulation: currently a series of major regulatory changes proposed to airportsCongestion: airports have increasingly become more congested, raising additional problems in short-run landing fee pricing but also long-run capacity expansionEvanka
5CompetitionExtent to which passengers are willing to travel between alternative airports offering overlapping routesLower landing fees when airports face airport competitionEvanka
6Countervailing PowerThe balancing of the market power of one group by that of another groupAirports charge airlines for routesIn non-congested airports, the charge for routes is cheaper in comparison to high-congested airports.Elise: (Competition and Landing Fee Emergence)For example, the market power of airports (the suppliers) are balanced by the market power of the airlines (the buyers)Airlines with many different routes get a lower rate than an airline with fewer routes.Airlines pay less (or get discounts) from non-congested/smaller airports.
7Bertrand Competition versus Cournot Competition Main distinction:Bertrand competitive firms compete by setting prices simultaneouslyCournot competitive firms compete by setting quantities simultaneously, which in turn affect priceDecisions are made individuallyLouis
8Concentration and Competition Proposition 1: Whenever an airport industry is monopolized, landing fee is always at the highest level.Proposition 2: Competition between separate airports reduces landing fee.Proposition 3: Under separate ownership, landing fees are higher under Bertrand competition compared to those under Cournot competition, when downstream market is concentrated.Proposition 4: With Cournot competition, uniform charges are always higher than discriminatory charges. With Bertrand competition, the opposite is true.Louis
9Price Cap Regulation of Airports Should the aeronautical price cap be based upon the “single-till” or “dual-till” approach?Stephanie
10IntroductionA price cap is the maximum price set for a specific productAirports are typically monopolistic providers of aeronautical servicesWithin the last 20 years, privatization of airports has increased, accompanied by some form of price regulation in the industryIssue of whether to adopt “single-till” or “dual-till” approach for airport regulation to increase consumer welfare and airport profitStephanie (Sierra speaks right after this “Before Elise begins explainning, here’s what you should know beforehand.)
11“Single-till” vs. “Dual-till” approach “Single-till” approach: revenue and costs determined from both aeronautical and commercial servicesRevenue from commercial activities will cover the deficits incurred from the aeronautical services“Dual-till” approach: revenue from aeronautical services onlyCosts incurred from aeronautical services are covered by aeronautical revenue onlyElise
13Determining Factors for the Model the price elasticity of demand for aeronautical servicesthe consumer surplus for commercial services when both aeronautical and commercial services are priced as marginal costElise
14ResultsBrings the price of commercial services into the sphere of regulatory controlImproves the boundaries of:the demand for aeronautical servicesthe value of consumer surplus for commercial servicesRequires the regulator to determine:a lower bound on the slope of the demand for aeronautical servicesan upper bound on the level of consumer surplus for commercial servicesEvanka
15Airplanes and Comparative Advantage Sierra: This section deals with transportation of goods using either airplanes or ground transport (boats, trains, trucks, etc.)
16Transportation: Air vs. Surface Demand side: Consumers are most concerned with timely deliverySupply side: Producers are most concerned with transportation costTransportation by air depends on value to weight ratioAir shipping costs increase faster with weight than surface shipping costsTherefore, goods with a higher value to weight ratio will most likely be shipped by airEvanka: So there needs to be a balance between time of delivery and transportation costs. Consumers don’t want to be waiting forever to get their product, where producers don’t want to spend a lot of money on transportation costs. Not going to ship a product from China by ground. Don’t ship a product from NOVA by air. [End] Stephanie is going to talk more about value to weight ratio.
17Comparative Advantage Textbook definition:“The ability to be better suited to the production of one good than to the production of another good.”Heavy goods (low value to weight ratio)High cost for air shippingSlow deliveryComparative advantage for nearby suppliersLightweight goods (high value to weight ratio)Relatively low air shipping costsAir suppliers can match timely deliveryComparative advantage for distant suppliersStephanie
18Percentage of U.S. Imports by Air Louis: This graph demonstrates the fact that distance suppliers are more likely to ship by air than by surface. The top 3 graphs suppliers have a low % of air imports to the US. While the middle 3 have a higher % of air imports because they’re farther away from the US. The father away the country is, the more likely they will use air transport.
19Specialization- Distance Matters! Falling air transport costsBenefit all suppliers, but they benefit far away suppliers disproportionallyLead to greater specialization for distant producersWith regards to U.S. imports, Canada and Mexico have higher market shares (greater comparative advantage) in goods which other countries do not ship by airThe probability of air shipment is strongly related to distance and unit valueStephanie
20The Southwest EffectElise: This section deals with what happened when Southwest in the 80s and 90s (a low cost air provider) entered the market with traditionally higher cost airline service providers.
21SouthwestOperates in dense, short-haul markets where it can provide frequent service50-70% lower unit costs than other major US airlinesDominates market share virtually everywhere it servesMost markets include another airline’s hub cityControlled or strongly affected price for more than 60% of travelers in dense markets under 500 milesEvanka: In the 90s southwest was the Fastest growing, most profitable US airlineMore than any other airline, was causing the industry to changeDoesn’t use the tradition hub-and-spoke model like a lot of other US airlinesHas very low operating costs… with Exception of America West, whose operating costs are 20% higherWorks on the west coastDominant airline (more than any other airline, is causing the industry to change)
22Main PointsReturn to profitability depends on developing lower-cost services in the short haul (0-500 miles) and increasing fares in the longer-haul (500+) markets.Competition sharply declinedInability to continue charging relatively high fares in short-haul markets would force a correction in the domestic industry’s long-haul pricing structure where fares were low in relation to costsThe government needs to encourage low-cost, new entrySierra: Other airlines are giving up competing with Southwest’s low-cost service for market share. Southwest’s continuing expansion will force other airlines to bring about a major change in their cost structures by developing new, low-cost services in short haul markets.The industry’s inability to continue to charge relatively high fares in short-haul markets will, in turn, force a correction in the domestic industry’s long-haul pricing structure where intense competition has produced fares that appear to be low in relation to costs.The government needs to encourage low-cost, new entry, due to the inability of existing airlines to compete with Southwest’s lower costs. This will check Southwest’s pricing behavior in the future and replace the service of other airlines that are scaling back service/exiting markets dominated by Southwest.
23Elise: (This graph shows that short-haul flights were more expensive than longer-haul flights compared to the industry standard)100 SIFL (standard industry fare level) – the lowest unrestricted coach fare in each market on July 1st of every year. This line is updated annually. In the short-haul the price stays relatively level to the SIFL. As the short-haul transfer to long-haul, the air fare drops. This is the opposite of what should be happening. Short term flights should be cheaper, while longer-haul flights should be more expensive.
24Some Numbers… Price in Southwest markets: Price charged in non-Southwest markets:0-250 miles: $190.92miles: $130.32Price in Southwest markets:0-250: $56.29: $57.61Dominant airline in top state marketsMore passengers than each of the Big Three (64%, 110%, and 27% more than American, Delta, and United, respectively)Louis: This slide is pretty self explanatory, it’s just to show you some numbers. We can see that the prices charged in markets where southwest is not operating are exponentially higher than the prices in markets where southwest is present.
25Effects of Southwest’s Entry Other airlines had stopped trying to compete with Southwest for market shareSince Southwest entered airports, carriers either exited or started to significantly increase prices due to a major loss of trafficIndustry profitability had declinedStephanie: Other airlines had stopped trying to compete with Southwest for market share…They are surrendering market share, and short-haul markets, to Southwest.Industry profitability had declined due to low long-haul prices and now too low short-haul prices due to Southwest’s competitive prices
26Southwest EffectUsing the “California Corridor” as an example, average prices are down by 1/3 and traffic is up 60% (on only 6% more capacity) since Southwest’s entry into the market.Average load factors have risen from under 50% to 67%Sierra
27Importance of New Entrants New entrants will be the only way to1. replace the service lost when airlines exited markets dominated by Southwest2. Exert cost competition on Southwest, which is fading3. Extend low-fare services to other marketsWithout new entrants, Southwest’s fares will increase to cover costs and to start extracting monopoly profits.Southwest’s costs have already increased in markets where it has pushed out competitors and attained a relatively full load levelSierra: Southwest offers lower charges as a monopolist than other major airlines do in the most competitive marketsHowever, fares in short-haul markets were increasing faster than the Standard Industry Fare Level (SIFL; the lowest unrestricted coach fare in each market on July 1st of every year). This is due to the competitors’ increasing of their prices in Southwest’s markets.Southwest, alone, isn’t enough to discipline industry prices in short-haul markets.
28BibliographyHaskel, J., AIozzi, A. and Valletti, T. “Market Structure, Countervailing Power and Price Discrimination: The Case of Airports.” CEPR Discussion:Currier, Kevin. “Price Cap Regulation of Airports: A New Approach.” Economics Bulletin. Vol. 12, No. 8. (2008): ppHarrigan, James. "Airplanes and Comparative Advantage." NBER Working Paper Series W11688 (2005).EconLit. 25 MarBennett, Randall. “The Southwest Effect.” Office of Aviation Analysis. May 1993: https://docs.google.com/a/virginia.edu/viewer?a=v&q=cache:4BUFbLMPXIIJ:ostpxweb.dot.gov/aviation/X-50%2520Role_files/Southwest%2520Effect.DOC+&hl=en&gl=us&pid=bl&srcid=ADGEESjqmeEQuxj-Rf84dn4Ajjq_zRfv2YIpnjUPfNhCNTIQTJiap_5DsoxYsyl6G8Xs9i6YD2XYDmxGsV5IMYYPgNYBM_A7TKvnXy7rm43jVwVa3AWnErXbnsVq0s9qxlUO4SWqPQ9i&sig=AHIEtbTflNJgQd8Eu6P00dBSLtUpzVt1uw&pli=1