Everyday Economics:
Applications in Aviation and Tourism
Michael Fung and Fred Ku
Decision Sciences and Managerial Economics,
CUHK Business School
Aviation Economics
Michael Ka Yiu Fung
Aviation Policy and Research Center,
CUHK Business School
Air 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: A380
US$390 Million (January, 2012)

Scale Economies
Why A380??
A380: 524 (3-class); 644 (2-class); 853 (1class)
Boeing 747-400: 416 (3-class); 524 (2class); 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/planespeaking/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 can
prevent 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 stayover 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

1.
2.
3.
4.
5.
6.
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
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.ht
ml
(English) (11 pages)
http://www.hkairport2030.com/en/information/publications.ht
ml
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/pressreleases/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 HKIA
1998
28.6m
2010
50.9m
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%
Passengers
Cargos
*m = million
Source: HKIA MP 2030 Summary; Annual Reports of HKIA
Facts about HKIA (cont’d)
Employment
Value Added
Importance
• Current employment on the airport
island: ~65,000 people
• The economic contribution by aviation
industry in 2008: HK$ 78 billion1 in
value added, or 4.6% of HK GDP
• 4 economic pillars2 rely heavily on
efficient flow of people and goods
1: Directly cited from the HKIA Master Plan 2030 Summary
2: financial services, trading and logistics, tourism, and producer and professional services
Competition
Airport
Nos of
Runways
Planned number
of runways
Beijing Capital
3
Guangzhou Baiyun
2
Planning to build a
2nd airport
5
Shanghai Pudong
Singapore Changi
Seoul Incheon
Tokyo Narita
3
2
3
2
5
3
5 by 2020
3
Shenzhen Bao’an
2
3
Source: HKIA MP2030 Summary; various airports’ websites
Reasons for Third Runway
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
Source: HKIA MP2030 Executive Summary
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
Project
Planning
Project
Approval
• Environmental
Impact
Assessment
studies
• Associated
design details
• Funding
options
• Statutory
& Govt
approvals
• Environme
ntal permit
• Foreshore
& seabed
gazettal
• Financial
• ~2 years
• ~1 year
Source: HKIA’s press release at March 20, 2012
Project
Implementatio
n
• Land
reclamation
• Detailed
designs
• Construction
of related
facilities
• Commissioni
ng of a 3rd
runway
• ~8 years
Funding

Borrowing


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


Significant borrowing may adversely affect the credit
ratings of AAHK
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 shortterm 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 Airport
Available at:
http://www.hkairport2030.com/en/information/p
ublications/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

Direct


Direct

Indirect

Catalytic
Indirect +
Induced
Indirect
Benefits


Induced

Spending of incomes by the
direct & indirect employees on
local goods & services
Catalytic Direct


supplies of goods and services
to the activities at the airport
E.g. utilities, fuel suppliers,
construction
Induced

Catalytic
Direct
Aviation-related business
Non-aviation-related business at
HKIA
Direct contribution of aviationrelated 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 projected
for 2009-2030
Ripple effects on each industry
are shown
Source: ESA’s Economic Impact Study for HKIA
Economic Multipliers 2006-2008 – used
for projections 2009-2030
Industry
Direct Revenue to Direct + Indirect
Value Added Multiplier
Air Transport
Tourism
Trade (re-exports)
Trade (retained imports)
Induced Value Added to Induced
Revenue Multiplier
Source: ESA’s Economic Impact Study for HKIA
Multiplier
0.311
0.563
0.128
0.111
0.605
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 Added
2008
2030
Value added
29,446
93,764
Share of GDP
1.75%
2.57%
Value added
32,040
42,211
Share of GDP
1.91%
1.16%
Value added
16,101
31,497
Share of GDP
0.96%
0.86%
Value added
10,272
(-12,644)
18,273
(-26,269)
Share of GDP
0.61%
(-0.75%)
0.50%
(-0.72%)
Value added
61,588
146,555
Share of GDP
3.67%
4.02%
107,012
257,843
6.37%
7.07%
Value Added ( HK$ Millions)
Direct Benefits
Indirect Benefits
Induced Benefits
Catalytic Benefits
Tourism
Trade
Catalytic Indirect +
Value added
Induced Benefits
Share of GDP
Overall
Value added
256,459
590,143
Share of GDP
15.27%
16.18%
1,679,000
3,647,000
GDP
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 – Employment
Employment (Persons)
Direct Benefits
Indirect Benefits
Induced Benefits
Catalytic Benefits
Tourism
Trade
Catalytic Indirect
Induced Benefits
+
2008
2030
Employment
61,604
141,141
% of labor force
1.69%
3.66%
Employment
66,455
95,416
% of labor force
1.83%
2.48%
Employment
57,399
104,075
% of labor force
1.58%
2.70%
Employment
32,116
(-39,532)
62,917
(-90,450)
% of labor force
0.88%
(-1.09%)
1.63%
(-2.35%)
Employment
78,402
218,574
% of labor force
2.16%
5.68%
263,506
645,480
7.24%
16.76%
Employment
559,482
1,267,603
% of labor force
15.38%
32.91%
3,637,200
3,851,300
Employment
% of labor force
Overall
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
Economic Impact Breakdown
2008 Value added breakdown
(% of GDP)
1.75
6.37
1.91
0.96
2030 Value added breakdown
(% of GDP)
2.57
7.07
4.52
4.28
Direct
Direct
Indirect
Indirect
Induced
Catalytic Direct
Catalytic Indirect + Induced
1.16
0.86
Induced
Catalytic Direct
Catalytic Indirect + Induced
Economic Contribution by APRC
Air Transport
& incidental
Services
Trade
Services
Direct
Benefits
Indirect
Benefits
Inbound
Tourism
Travel agents
&
Airline ticket
agents
Logistics
Miscellaneous
Services
Courier
Services
Land
Transport
Value Added of the Aviation Industry at
Current Prices
Unit: HK$ million (unless otherwise specified)
2005
Direct
benefits
Air transport
and incidental
services
Value added
Share of GDP
(b.p. and curr. p.)
Value added
Trade services
Share of GDP
(b.p. and curr. p.)
Value added
Indirect
benefits
Tourism
Share of GDP
(b.p. and curr. p.)
Value added
Logistics
Share of GDP
(b.p. and curr. p.)
Value added
Overall
Share of GDP
(b.p. and curr. p.)
GDP (b.p. and curr. p.)
2006
2007
2008
2009
44,661
43,786
46,489
32,075
42,422
3.29%
3.01%
2.94%
2.01%
2.74%
59,151
60,962
66,530
64,070
59,549
4.35%
4.20%
4.21%
4.02%
3.84%
7,952
9,333
9,904
9,949
8,026
0.59%
0.64%
0.63%
0.62%
0.52%
6,363
6,330
6,599
6,047
6,286
0.47%
0.43%
0.42%
0.38%
0.41%
118,127
120,411
129,523
112,141
116,283
8.69%
8.29%
8.20%
7.04%
7.50%
1,452,800
1,580,100
1,592,900
1,550,900
1,359,200
Part III
Environmental
Economics in Aviation
Social Costs – Pollution
Pollution
Water
Quality
Marine
Ecology
Air
Quality
Fisheries
Noise
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
% of emissions
CO2, H2O, NOx, SOx,
Particulates
VOCs , CO
airport ground level
operations and Landing &
Take-Offs
10%
30%
higher altitudes
90%
70%


Emissions at ground level affect health: lung
diseases, respiratory diseases,…
Emissions at higher altitudes may cause global
warming and climate change
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


No of allowances in 2012



97% of 2004-06 average:212,892,052 tonnes of CO2
No of allowances from 2013 onwards


219,476,343 tonnes of CO2
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!