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

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

Aviation Economics

Aviation Economics Microeconomics in Aviation Macroeconomics in Aviation Environmental Economics in Aviation

Microeconomics in Aviation Part I Microeconomics in Aviation

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

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

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

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

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

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

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

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

Scope Economies Airlines: passenger and cargo

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.

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: http://www.seatplans.com/advice/plane-speaking/aviation-glossary

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

Network Economies Cathay Pacific – Hub Carrier “Over 111 destinations worldwide” Source: Cathay Pacific http://aviationknowledge.wikidot.com

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.

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.

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

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.

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.

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

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

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

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.

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

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

Macroeconomics in Aviation Part II Macroeconomics in Aviation

Related Links - HKIA Master Plan 2030 Executive Summary: (Chinese) (11 pages) http://www.hkairport2030.com/tc/information/publications.html (English) (11 pages) http://www.hkairport2030.com/en/information/publications.html Videos: (Chinese) http://www.hkairport2030.com/tc/information/videos.html (English) http://www.hkairport2030.com/en/information/videos.html

Additional Reference Materials Airport Authority Hong Kong (2012). Press release at March 20, 2012. Retrieved from http://www.hongkongairport.com/eng/media/press-releases/pr_1060.html (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。

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

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

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

Reasons for Third Runway Source: HKIA MP2030 Executive Summary

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

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

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

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

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: http://www.hkairport2030.com/en/information/publications/consultancy_reports.html (ii) Aviation Policy and Research Center (APRC), Chinese University of Hong Kong. 2012. Economic Contribution of Aviation Industry

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

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.

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

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

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

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

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

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

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

Economic Contribution by APRC Miscellaneous Services Land Transport

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

Environmental Economics in Aviation Part III Environmental Economics in Aviation

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

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

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

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 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 EU’s climate exchanges. Permit price ~ € 10 per tonne on March 2012

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

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 CO2 No of allowances in 2012 97% of 2004-06 average:212,892,052 tonnes of CO2 No of allowances from 2013 onwards 95% of 2004-06 average: 208,502,525 tonnes of CO2 Target: Cut 50% carbon by 2030 1 allowance can emit 1 tonne of CO2 Source: European Commission

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

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: http://ec.europa.eu/environment/ets/registrySearch.do

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

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?

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