Everyday Economics:Applications in Aviation and Tourism

Michael Fung and Fred KuDecision Sciences and Managerial Economics,

CUHK Business School

Aviation Economics

Michael Ka Yiu FungAviation Policy and Research Center,

CUHK Business SchoolAir Transport Licensing Authority,

HKSAR

Aviation Economics

Aviation Economics

Microeconomics in Aviation Macroeconomics in Aviation Environmental Economics 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: A380US$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 canprevent 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:1. Cathay Pacific Catering Services (HK) Limited – Airline Catering2. Asia Miles Limited – Loyalty Programme3. Cathay Pacific Service Limited – Cargo Terminal4. Hong Kong Airport Services Limited – Aircraft Ramp Handling5. Vogue Laundry and Cleaning Limited – Laundry and Dry Cleaning6. 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

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 HKIA1998 2010

Passengers 28.6m 50.9m

Cargos 1.6m tonnes 4.1m tonnes

Air Traffic Movements (ATMs)/Day

450 850

Number of Destinations

120 160

% of transfer/Transit passengers

25% 35.1%

*m = millionSource: HKIA MP 2030 Summary; Annual Reports of HKIA

Facts about HKIA (cont’d)

1: Directly cited from the HKIA Master Plan 2030 Summary2: financial services, trading and logistics, tourism, and producer and professional services

CompetitionAirport Nos of

RunwaysPlanned number of runways

Beijing Capital 3 Planning to build a 2nd airport

Guangzhou Baiyun 2 5

Shanghai Pudong 3 5

Singapore Changi 2 3

Seoul Incheon 3 5 by 2020

Tokyo Narita 2 3

Shenzhen Bao’an 2 3

Source: HKIA MP2030 Summary; various airports’ websites

Reasons for Third Runway

Source: HKIA MP2030 Executive Summary

By 2030, it is expected to have 97m passengers, 8.9m tonnes of cargo, 602,000 flight movements/year

Traffic may be lost to other airports due to “capacity crunch” and increasing connectivity

3rd runway allows aviation network to continue to grow without constraints and enhanced connectivity

that supports Hong Kong’s competitiveness

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

Source: HKIA’s press release at March 20, 2012

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

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 AirportAvailable 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

CatalyticIndirect +Induced

CatalyticDirect

Induced

Indirect

Direct

Benefits

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

Regional Input-output Models

Economic multipliers are generated

Indirect & induced benefits are projectedfor 2009-2030

Ripple effects on each industryare shown

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 AddedValue Added ( HK$ Millions) 　 2008 　 2030

Direct Benefits Value added 29,446 93,764

Share of GDP 1.75% 　 2.57%

Indirect Benefits Value added 32,040 　 42,211

Share of GDP 1.91% 　 1.16%

Induced Benefits Value added 16,101 31,497

Share of GDP 0.96% 0.86%

Catalytic Benefits Tourism Value added 10,272 (-12,644) 　 18,273 (-26,269)

Share of GDP 0.61% (-0.75%) 0.50% (-0.72%)

Trade Value added 61,588 　 146,555

Share of GDP 3.67% 　 4.02%

Catalytic Indirect + Value added 107,012 257,843

Induced Benefits Share of GDP 6.37% 7.07%

Overall Value added 256,459 　 590,143

Share of GDP 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 – EmploymentEmployment (Persons) 2008 　 2030

Direct Benefits Employment 61,604 　 141,141

% of labor force 1.69% 　 3.66%

Indirect Benefits Employment 66,455 95,416

% of labor force 1.83% 2.48%

Induced Benefits Employment 57,399 　 104,075

% of labor force 1.58% 　 2.70%

Catalytic Benefits Tourism Employment 32,116 (-39,532) 62,917 (-90,450)

% of labor force 0.88% (-1.09%) 1.63% (-2.35%)

Trade Employment 78,402 　 218,574

% of labor force 2.16% 5.68%

Catalytic Indirect + Induced Benefits

Employment 263,506 　 645,480

% of labor force 7.24% 　 16.76%

Overall Employment 559,482 1,267,603

% of labor force 15.38% 32.91%

Employment 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

0.96

1.911.75

6.37

4.28

Direct

Indirect

Induced

Catalytic Direct

Catalytic Indirect + Induced

1.160.86

4.52

7.07

2.57

Direct

Indirect

Induced

Catalytic Direct

Catalytic Indirect + Induced

2008 Value added breakdown(% of GDP)

2030 Value added breakdown(% of GDP)

Economic Contribution by APRC

Travel agents&

Airline ticketagents

Air Transport& incidental

Services

DirectBenefits

Inbound Tourism

Logistics

Trade Services

IndirectBenefits

Courier Services

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

Value added 59,151 60,962 66,530 64,070 59,549

Share of GDP 4.35% 4.20% 4.21% 4.02% 3.84%

(b.p. and curr. p.)

Tourism

Value added 7,952 9,333 9,904 9,949 8,026

Share of GDP 0.59% 0.64% 0.63% 0.62% 0.52%

(b.p. and curr. p.)

Logistics

Value added 6,363 6,330 6,599 6,047 6,286

Share of GDP 0.47% 0.43% 0.42% 0.38% 0.41%

(b.p. and curr. p.)

Overall

Value added 118,127 120,411 129,523 112,141 116,283

Share of GDP 8.69% 8.29% 8.20% 7.04% 7.50%

(b.p. and curr. p.)

GDP (b.p. and curr. p.) 1,359,200 1,452,800 1,580,100 1,592,900 1,550,900

Part III

Environmental Economics in Aviation

Social Costs – Pollution

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

Emissions at ground level affect health: lung diseases, respiratory diseases,…

Emissions at higher altitudes may cause global warming and climate change

% of emissions CO2, H2O, NOx, SOx, Particulates

VOCs , CO

airport ground level operations and Landing & Take-Offs

10% 30%

higher altitudes 90% 70%

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?

Thank you!