On the Effects of Airport Capacity Expansion Under Responsive Airlines and Elastic Passenger Demand

Abstract

This paper investigates the effect of airport expansion on air traffic and its implications on airport congestion, airline competition and the social welfare, considering different airline market structures (i.e., perfect substitutes market or imperfect substitutes market) and airport administrative regimes (i.e., zero-profit, profit-maximizing, and welfare-maximizing). We develop an analytical tri-level model to examine the air traffic equilibrium in the airport-airline-passenger system, the effect of airport capacity expansion on the traffic equilibrium, and the decisions of different stakeholders, i.e., airport’s decision on flight charge in the first level, airlines' decisions on flight volume and airfare in the second level, and the passenger choice equilibrium in the third level. The analysis in this paper suggests that (i) airport capacity expansion may induce the airline market to over schedule flights and lead to a more congested airport (i.e., capacity paradox); (ii) with a given airport charge, the capacity paradox is more likely to occur in airline market with fewer competitive airlines; (iii) given the same airport capacity and traffic, capacity paradox is more likely to occur under a welfare-maximizing airport operator (compared to zero-profit and profit-maximizing); (iv) airlines with market power will internalize a portion of airport congestion based on their market share, while a leader airline with the knowledge of the follower's response will scale up/down their airfare in order to maximize its profit; (v) under different market structures, capacity expansion always increases the aggregate traffic volume when the airport charge is fixed.

Keywords: Airport expansion, Air traffic congestion, Airlines competition, Sequential game, Welfare effects