Everyday Economics: Applications in Aviation and Tourism

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

2. Aviation Economics Michael Ka Yiu FungAviation Policy and Research Center, CUHK Business SchoolAir Transport Licensing Authority, HKSAR

3. Aviation Economics

4. Aviation Economics Microeconomics in Aviation Macroeconomics in Aviation Environmental Economics in Aviation

5. Part I Microeconomics in Aviation

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

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

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

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

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

11. 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

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

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

14. Scope Economies Airlines: passenger and cargo

15. 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.

16. 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

17. 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

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

19. 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.

20. 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.

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

22. 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.

23. 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.

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

25. 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

26. 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

27. 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.

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

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

30. Part II Macroeconomics in Aviation

31. 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

32. 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。

33. Facts about HKIA *m = million Source: HKIA MP 2030 Summary; Annual Reports of HKIA

34. Facts about HKIA (cont’d) 1: Directly cited from the HKIA Master Plan 2030 Summary 2: financial services, trading and logistics, tourism, and producer and professional services

35. Competition Source: HKIA MP2030 Summary; various airports’ websites

36. Reasons for Third Runway Source: HKIA MP2030 Executive Summary

37. Details of the 3rd Runway • The forecasted flight movements at 2030 = 602,000 • Current capacity (as at 2010) = 360,000 Source: HKIA MP2030 Summary

38. Schedule of the Third Runway Source: HKIA’s press release at March 20, 2012

39. 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

40. 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

41. 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

42. 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

43. 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.

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

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

46. Economic Multipliers 2006-2008 – used for projections 2009-2030 Source: ESA’s Economic Impact Study for HKIA

47. 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

48. Total Economic Impact with 3rd Runway – Value Added 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

49. Total Economic Impact with 3rd Runway – Employment 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

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