1. 1 Prof. 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

2. 2 Prof. 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

3. 3 Prof. Dr. Hans-Martin Niemeier Marshallian Equilibrium Analysis I. Theory of Marginal Cost Pricing

4. 4 Prof. 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.

5. 5 Prof. 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.

6. 6 Prof. Dr. Hans-Martin Niemeier Small airports: Deficit problem P Q D p R -AC(Q R ) MC(Q) AC(Q) QRQR p opt Loss

7. 7 Prof. 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

8. 8 Prof. 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

9. 9 Prof. 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

10. 10 Prof. 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

11. 11 Prof. Dr. Hans-Martin Niemeier Airports with increasing AC P Q D2D2 AC(Q) q*q* MC(Q) D1D1 MC 1 p1p1 c*c* p2p2 MC 2

12. 12 Prof. 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

13. 13 Prof. 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. 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

15. 15 Prof. 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. 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. 17 Moderately Busy Peak Movements P*pP*p X* o DPDP DoDo P‘sP‘s K PrPr XoXo PsPs Price

18. 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. 19 Very Busy Airports Movements DPDP DoDo K P Price

20. 20 Prof. 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?

21. 21 Prof. 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?

22. 22 Prof. Dr. Hans-Martin Niemeier Ramsey Pricing P Q1SQ1S P Q2SQ2S Market 1Market 2 Q1aQ1a Q2aQ2a MC π1π1 π2π2 DWL 1 DWL 2 p1ap1a p2ap2a