A General Equilibrium Analysis of Airport Pricing, Capacity and Regulation

Abstract

Using a general-equilibrium model that includes consumers, airlines, and an airport with both aeronautical service and non-aeronautical service, this paper investigates the airport’s decisions on its aeronautical charge and capacity, as well as the size of its non-aeronautical service. In contrast to the existing literature, we formerly model an airport’s non-aeronautical service by taking into account both the substitutability between goods sold at the airport and those sold elsewhere, and the endogenous determination of the size of the airport’s non-aeronautical service. After characterizing the results for welfare maximization, we find that the self-financing property does not hold. Apart from carriers’ market power as a source for the failure of the self-financing property, we further identify the presence of non-aeronautical service as a new source. Essentially, the airport has an incentive to reduce airport charge as this stimulates its passenger volume, which in turn will increase the unit rent it can derive from shop space. Furthermore, we derive the results for profit maximization by a monopolistic airport, and demonstrate that the imposition of two taxes, one on the airport’s aeronautical service and the other on the airport capacity investment, can recover the welfare-maximization results. Our analysis on airport regulation shows that dual-till regulation yields higher welfare than single-till regulation, as long as the profit from non-aeronautical service is positive. This result is in contrast to the prevailing wisdom in the literature, which in general favors single-till regulation.