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Airplanes Sierra Prochna, Elise Lepe, Louis Hwang, Evanka Weerasinghe, and Stephanie Wilson Louis: Our group did our presentation on airplanes in the economy.

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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:

1 Airplanes Sierra Prochna, Elise Lepe, Louis Hwang, Evanka Weerasinghe, and Stephanie Wilson Louis: 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.

2 Competition and Landing Fee Emergence
Sierra: Airports make money numerous ways. One way is by charging airlines to land.

3 Airline 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 exist Sierra: This means they were all owned by the government. Airlines can bargain or change prices that the airports were charging for landing.

4 Changes now Market structure: low cost airlines have brought new, often non-central airports, into effective competition Privatization: 55 countries have partially or totally privatized their airports Regulation: currently a series of major regulatory changes proposed to airports Congestion: airports have increasingly become more congested, raising additional problems in short-run landing fee pricing but also long-run capacity expansion Evanka

5 Competition Extent to which passengers are willing to travel between alternative airports offering overlapping routes Lower landing fees when airports face airport competition Evanka

6 Countervailing Power The balancing of the market power of one group by that of another group Airports charge airlines for routes In 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.

7 Bertrand Competition versus Cournot Competition
Main distinction: Bertrand competitive firms compete by setting prices simultaneously Cournot competitive firms compete by setting quantities simultaneously, which in turn affect price Decisions are made individually Louis

8 Concentration 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

9 Price Cap Regulation of Airports
Should the aeronautical price cap be based upon the “single-till” or “dual-till” approach? Stephanie

10 Introduction A price cap is the maximum price set for a specific product Airports are typically monopolistic providers of aeronautical services Within the last 20 years, privatization of airports has increased, accompanied by some form of price regulation in the industry Issue of whether to adopt “single-till” or “dual-till” approach for airport regulation to increase consumer welfare and airport profit Stephanie (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 services Revenue from commercial activities will cover the deficits incurred from the aeronautical services “Dual-till” approach: revenue from aeronautical services only Costs incurred from aeronautical services are covered by aeronautical revenue only Elise

12 The Model (graph) Elise

13 Determining Factors for the Model
the price elasticity of demand for aeronautical services the consumer surplus for commercial services when both aeronautical and commercial services are priced as marginal cost Elise

14 Results Brings the price of commercial services into the sphere of regulatory control Improves the boundaries of: the demand for aeronautical services the value of consumer surplus for commercial services Requires the regulator to determine: a lower bound on the slope of the demand for aeronautical services an upper bound on the level of consumer surplus for commercial services Evanka

15 Airplanes and Comparative Advantage
Sierra: This section deals with transportation of goods using either airplanes or ground transport (boats, trains, trucks, etc.)

16 Transportation: Air vs. Surface
Demand side: Consumers are most concerned with timely delivery Supply side: Producers are most concerned with transportation cost Transportation by air depends on value to weight ratio Air shipping costs increase faster with weight than surface shipping costs Therefore, goods with a higher value to weight ratio will most likely be shipped by air Evanka: 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.

17 Comparative 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 shipping Slow delivery Comparative advantage for nearby suppliers Lightweight goods (high value to weight ratio) Relatively low air shipping costs Air suppliers can match timely delivery Comparative advantage for distant suppliers Stephanie

18 Percentage 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.

19 Specialization- Distance Matters!
Falling air transport costs Benefit all suppliers, but they benefit far away suppliers disproportionally Lead to greater specialization for distant producers With regards to U.S. imports, Canada and Mexico have higher market shares (greater comparative advantage) in goods which other countries do not ship by air The probability of air shipment is strongly related to distance and unit value Stephanie

20 The Southwest Effect Elise: 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.

21 Southwest Operates in dense, short-haul markets where it can provide frequent service 50-70% lower unit costs than other major US airlines Dominates market share virtually everywhere it serves Most markets include another airline’s hub city Controlled or strongly affected price for more than 60% of travelers in dense markets under 500 miles Evanka: In the 90s southwest was the Fastest growing, most profitable US airline More than any other airline, was causing the industry to change Doesn’t use the tradition hub-and-spoke model like a lot of other US airlines Has very low operating costs… with Exception of America West, whose operating costs are 20% higher Works on the west coast Dominant airline (more than any other airline, is causing the industry to change)

22 Main Points Return 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 declined Inability 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 costs The government needs to encourage low-cost, new entry Sierra: 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.

23 Elise: (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.

24 Some Numbers… Price in Southwest markets:
Price charged in non-Southwest markets: 0-250 miles: $190.92 miles: $130.32 Price in Southwest markets: 0-250: $56.29 : $57.61 Dominant airline in top state markets More 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.

25 Effects of Southwest’s Entry
Other airlines had stopped trying to compete with Southwest for market share Since Southwest entered airports, carriers either exited or started to significantly increase prices due to a major loss of traffic Industry profitability had declined Stephanie: 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

26 Southwest Effect Using 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

27 Importance of New Entrants
New entrants will be the only way to 1. replace the service lost when airlines exited markets dominated by Southwest 2. Exert cost competition on Southwest, which is fading 3. Extend low-fare services to other markets Without 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 level Sierra: Southwest offers lower charges as a monopolist than other major airlines do in the most competitive markets However, 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.

28 Bibliography Haskel, 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): pp Harrigan, James. "Airplanes and Comparative Advantage." NBER Working Paper Series W11688 (2005).EconLit. 25 Mar Bennett, 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


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