1Prof. Dr. Hans-

Martin Niemeier

Introduction and overview of ongoing research issues

GAP Research Workshop Berlin, April 10 2008

Hans-Martin Niemeier University of Applied Sciences, Bremen

2Prof. Dr. Hans-

Martin Niemeier

Theory of Optimal Pricing of Airports I. Theory of Marginal Cost Pricing

• Efficient rationing of existing capacity• Optimal level of investment• Allocative efficiency and welfare maximization

• Cost efficiency II. Second best pricing for airports

• Small non busy airports with decreasing average costs

• Airports with increasing average costs • Busy and very busy airports

III.Summary and further research

3Prof. Dr. Hans-

Martin Niemeier

Marshallian Equilibrium Analysis

I. Theory of Marginal Cost Pricing

P

P1

P2

P3

OutputX1 X2 X3

LRAC

D

SRMC

SRAC

4Prof. Dr. Hans-

Martin Niemeier

Marshallian Equilibrium Analysis

I. Theory of Marginal Cost Pricing

• Marginal cost pricing leads to an efficient rationing of existing capacities. The users are charged with the opportunity cost to produce the demanded output. Historical costs do not matter. The output is distributed to those with the greatest willingness to pay.

5Prof. Dr. Hans-

Martin Niemeier

Marshallian Equilibrium Analysis

I. Theory of Marginal Cost Pricing

• Marginal cost pricing leads to an optimal level of investment. The firms are indifferent in their decision to use more fixed or variable capital.

• Marginal cost pricing leads to allocative efficiency as welfare is maximized. The social marginal benefit of producing the last output unit equals its social marginal costs.

• Marginal cost pricing leads to cost efficiency. Output is produced at the minimum of average costs. All returns scale are exhausted. The firms are producing technically efficient and using an efficient combinations of production factors.

6Prof. Dr. Hans-

Martin Niemeier

Small airports: Deficit

problem

P

Q

D

pR-AC(QR)

MC(Q)

AC(Q)

QR

popt

Loss

7Prof. Dr. Hans-

Martin Niemeier

Second best solutions • What is second best? Price and quantity

combination maximizing consumer and producer surplus subject to the airport breaking even.

• Price at marginal cost plus subsidy. • Single product airport: Price at average

cost. Higher prices, lower consumer surplus.

• Multiproduct airport: Two-part tariffs or Ramsey Pricing.

Small airports: Deficit

problem

8Prof. Dr. Hans-

Martin Niemeier

Ramsey Pricing

• Start from p= MC

• Optimize trade off. Raising price

• increases profitability and break even

• decreases welfare (or increases

deadweight loss)

• Assumption: Independent Demand for

two products. Cross price elasticities are

zero.

• Two products have the same MC.

• How price then two products?

Small airports: Deficit

problem

9Prof. Dr. Hans-

Martin Niemeier

Ramsey Pricing

• The airport should mark up the price

above marginal cost inversely to the

price elasticity of demand.

• Have airport charges a Ramsey pricing

structure?

• Pros and cons of weight based charges

Small airports: Deficit

problem

10Prof. Dr. Hans-

Martin Niemeier

Pricing of weak airport monopolies

• While the small airports might be strong

natural monopolies large hubs have lost

this status and became legal monopolies

as entry has been blocked by the

authorities.

• These airports are operating under

constant or even slight increasing long

run average costs but demand might not

be strong enough two sustain two

airports.

Airports with increasing

AC

11Prof. Dr. Hans-

Martin Niemeier

Airports with increasing

AC

P

Q

D2

AC(Q)

q*

MC(Q)

D1

MC1

p1

c*

p2

MC2

12Prof. Dr. Hans-

Martin Niemeier

Pricing of weak airport monopolies

• Marginal cost pricing is possible as the

welfare maximising price covers costs.

• Profits should not be interpreted as a

market failure.

• The monopoly is sustainable because

entry is not possible.

• Such an airport should not adopt Ramsey

pricing.

• The structure of charges should reflect

the marginal costs of each product.

Airports with increasing

AC

13Prof. Dr. Hans-

Martin Niemeier

Pricing for busy and very busy airports• Background

• Short run. Fixed capacity.

• Busy versus very busy airport

• What are the short run problems to

implement marginal cost pricing?

• What are the long run problems?

Airports with increasing

AC

14

Background

• Excess demand for busy airports• Charges are regulated at non-market clearing

levels leading to misallocation, queues and rents• Ration by queues (US)• Could ration by prices (but where?)• Ration by slots (outside US)• Allocate slots by grandfathering• Limited slot trading leads to inefficient allocation

15Prof. Dr. Hans-

Martin Niemeier

Pricing for busy and very busy airports• What are the short run problems to

implement marginal cost pricing?

• Set capacity at optimal level.

• Optimal price structure

• Optimal allocation system

Airports with increasing

AC

16

Pricing under Regulation

• Regulation stops rationing prices from being used

• Slots must be allocated

• Peak prices are irrelevant- slots do the rationing

• But off peak prices are relevant- set at MC

• Achieve efficient use of airport at off peak

17

Moderately Busy Peak

Movements

P*p

X*o

DP

Do

P‘s

K

Pr

Xo

Ps

Price

18

Very Busy Regulated Airports

• Price regulation means that prices at peak and off peak are too low to ration capacity- slots must be used all the time

• Prices are irrelevant- slots do it all

• With non homogeneous movements, there should be uniform prices

19

Very Busy Airports

Movements

DP

Do

K

P

Price

20Prof. Dr. Hans-

Martin Niemeier

Pricing for busy and very busy airports• What are the long run problems?

• Price regulation and slot allocation stops prices

from market clearing levels.

• Price mechanism does not trigger off a long term

equilibrium. However, an unregulated monopolist

might under invest to reduce output to Cournot

monopoly prices and lumpiness of investment

might not be solved by contracts.

• Does regulation set incentives for optimal

investments?

21Prof. Dr. Hans-

Martin Niemeier

Theory of Optimal Pricing of Airports III.Summary & further research• Principles of marginal cost pricing are not

followed• Some evidence that prices are not optimal• Welfare loss might be relevant. Focus of research

• What is the level of charges in Europe? Has it changed?

• What is the structure of charges in Europe? Has it changed?

• What are the pro and cons of subsidies? • What is the level and structure of

environmental charges?

22Prof. Dr. Hans-

Martin Niemeier

Ramsey Pricing

P

Q1S

P

Q2S

Market 1 Market 2

Q1a Q2

a

MC MC

π1 π2

DWL1

DWL2

p1a p2

a