Abstract Pricing the Airport Infrastructure for the Airbus A380: Efficient Pricing and Dynamic Inconsistency The introduction of the new large aircraft, the Airbus A380, will require investments by airports which will be in the nature of sunk costs, such as in widening runways. These pose problems for pricing, cost recovery and investment evaluation. Short run efficiency involves not imposing any specific charge for the use of the aircraft, meaning that users will not face the costs they impose. This can lead to a dynamic inconsistency problem, whereby following optimal policies at all points of time leads to non-optimality in the long run. This could lead to excessive investment in accommodating the A380.
New Large Aircraft
Cost benefit analysis
JEL Classification Number L93 Air Transportation
I Introduction The new large aircraft, the Airbus A380, is due to come into service by 2006. Before this happens, most airports will need to invest so as to be able to handle it. Many will need to widen runways, realign taxiways and redevelop terminals. Much of the investment needed will be in the form of sunk costs, and the marginal costs of operating the extended facilities will often be negligible. Thus the costs imposed by the A380 using the runway will be small, and comparable to those of other aircraft.
An obvious question is who should pay for the costs of the investment to make airports capable of accommodating the new aircraft. As airports invest to handle the A380, they are considering it. It is a deceptively simple question, which poses a number of complexities. If the objective is to achieve efficiency, in the short run and the long run, pricing and investment criteria need to be determined.
Each of these issues is examined briefly in this paper. However one particular risk, that of dynamic inconsistency of optimal plans, is given particular attention. This is a situation in which following optimal policies at each point of time leads to less than optimal outcomes over time. This problem has been analysed in the macro literature, though it is equally pertinent in the micro context. A possible example of this occurred when airlines first bought jet aircraft- these required investments by airports in longer runways and when airlines chose aircraft which required stronger and more expensive runways than the alternative aircraft on offer.
The nature and possibility of dynamic inconsistency of optimal plans is considered first. After this, the Airbus A380 and its airport requirements are considered. In section IV, optimal pricing in the short run is considered, and following this, the problem of optimising investment is considered. With this basis, the possibility of consistently efficient policies in the short run leading to long run non-optimality, when airlines effectively play a game with airports, is examined. This concludes that there is a risk of excessive investment. Finally, the key points of the paper are synthesised and some broad conclusions are drawn.
II Efficient Pricing and Dynamic Inconsistency
When government agencies seek to implement policies which are optimal, it is possible that a course of action which is optimal at every point of time will be non-optimal over time. This is a possibility which has been explored by Kydland and Prescott (1977), and which has received considerable attention in macroeconomics. It has been explored also in the context of tax policy, where the efficient taxation of capital depends on whether it has been sunk or not (Blanchard and Fischer, 1989, pp 592-596). It has received rather less attention in microeconomics, though it is equally applicable, especially where substantial sunk costs are involved. Two of the examples of the problem which Kydland and Prescott give are microeconomic problems, dealing with flood control investments and patent policy.
The problem arises when the agency commits to implementing an optimal policy at each point of time. Normally, efficient pricing in the short run leads to efficiency in the long run. However, there are exceptions to this. For example, the agency may incur a sunk cost, after which marginal costs are zero. Efficient pricing then would involve zero prices. The agency has to choose whether to incur the sunk cost. However this commitment to zero prices may induce users to commit to courses of action which, after the event, make it worthwhile for the agency to incur the sunk cost. In spite of this, it is possible that the gain from the course of action may be less than the sunk cost- in short, it is optimal not to incur the sunk cost, but to allow higher costs to be incurred by users later. Following a short run optimal policy all the time- in this case setting prices at zero- does not result in the optimum in the long run being achieved.
There have already been examples of this in the aviation sector. At the time jets were first being introduced, the two main options for long haul aircraft were the Boeing 707, and the Douglas DC8. The two differed in their runway requirements. The DC8 had landing gear which had lower wheel loadings and thus which required less strong and therefore, less expensive, runways. In other respects it was less preferred. Runway strengthening is a sunk cost. Once the runway had been strengthened, the marginal cost of using it was approximately the same, at close to zero, for both types of aircraft. Optimal pricing thus required the same user charges for both aircraft. In this situation, it is possible that the least cost solution all-up would have been for airlines to purchase the less preferred aircraft, but for airports to have invested in the lower cost runways. Since airports were committed to optimal pricing, and this did not involve any pricing penalty for the Boeing 707, airlines tended to buy the Boeing. Granted that airlines had purchased the Boeing 707, the optimal policy for airports was to strengthen their runways, to be able to cope with the dominant choice of aircraft. If airlines which purchased the Boeing 707 had faced the costs of stronger runways, they might have opted for the DC8 instead- however short run optimisation demanded that airport charges for the two types of aircraft be the same. There was no way in which the airports could both price to optimise use, and give airlines the incentive to choose the aircraft which minimised the overall costs. In a sense, the airlines and aircraft manufacturers played a game against the airports and won.
Another example also occurred when jets were being introduced. The new jets required longer runways than existing aircraft, though they could have been designed to use shorter runways, at some additional capital cost. Manufacturers made, and airlines bought, the new jets, and once the longer runways were in place, the cost of using them was the same for aircraft regardless of whether they capable of using shorter runways. Manufacturers faced no incentive to build aircraft capable of using shorter runways, though this could have been a more efficient option in the long run (see Doganis, 1992, pp 80-84). This problem also arises in similar contexts, for example, when ports need to be dredged to accommodate larger vessels.
This problem seems likely to reoccur with the introduction of the new large aircraft, the Airbus A380. This aircraft will require wider runways than many airports currently have, and additional terminal facilities, along with larger parking areas. Many of the costs associated with these will be sunk costs- for example, the widening of the runways would incur sunk costs. The A380 will require capital expenditure by the airports, but it will lead to cost savings which will accrue to the airlines which operate it. The question arises of who should pay for the extra costs of accommodating the A380. If prices are set efficiently, since the marginal costs of the A380 in using an airport runway are the same as for other aircraft, (approximately zero), this implies that A380s should not be charged any more than other aircraft. If so, airlines will not take the extra costs of accommodating the A380 into their purchasing decisions, and will opt for the A380 even when smaller aircraft would be more cost effective, taking into account both airline and airport costs. Further, taking a step back, in its decision to incur sunk costs to develop the A380, the manufacturer may have bet that airports would not pass on the costs of accommodating it, and this may have made it more willing to commit to it.
Alternatively, it is possible that airports will impose additional charges on the use of A380s to recoup the sunk costs of accommodating them. This will make airlines take the airport costs into account when they decide whether to purchase the A380, and this will result in minimisation of overall capital costs. However, this will introduce a short run inefficiency- since it will be more expensive to schedule an A380 into an airport, airlines will have a disincentive to use them even when they are the most efficient choice of aircraft. The upshot is that there is no single best way to price for the A380- short run optimisation can create an excessive incentive for airlines to choose the aircraft, while using prices to condition long run choices results in inefficient utilisation of airports.
III The Airbus A380, Airport Costs and Pricing The Airbus A380 is a substantially larger passenger and freight aircraft than any currently flying. The usual stated capacity is 550 passengers, though it will be capable of carrying more, depending on seat pitch. It will be able to offer lower costs per passenger than long haul aircraft currently in service, such as the Boeing 747, or aircraft currently being delivered, such as the Boeing 777, the Airbus A330 and Airbus A340. Many of the long haul airlines of the world have confirmed orders for it, including European airlines such as Lufthansa, and Asia-Pacific airlines such as Singapore Airlines and Qantas- each of these has 12-15 aircraft on order. However the largest order has been from Emirates, a rapidly growing Middle Eastern airline, which has around 40 aircraft on order. The A380 is scheduled to come into service in 2006.
Most or all airports will require some investments, sometimes substantial, in order to be able to accommodate the A380 (see Barros and Wirasinghe, 2002; Holzschneider, 2004). It has a significantly wider wingspan than the largest aircraft currently in use. This will require larger separations in taxiways, and wider runways. The A380 will be more demanding of apron and parking space. Terminals will need to be adapted to handle it. Since it is a double deck aircraft, new double deck air bridges will be required if turnaround times are to be kept at levels currently achieved with smaller aircraft. Within the terminals, larger gate holding areas will be needed for the larger numbers of passengers.
These adaptations will impose costs on airports. The exact cost will vary from airport to airport, and will depend on the current stage of development and on the current layout. Some adaptations may not be very costly. For example, if the airport is upgrading its terminals, building new gates and facilities capable of handling the A380 need not add much, if anything, to costs. Facilities will need to be larger, but they may not be more expensive, on a per passenger basis, than existing facilities. Where terminals are adequate and upgrading is not contemplated, it will be necessary for the airport to incur more capital expenditure or to incur such expenditure earlier than originally planned- this will add to costs. To some extent, a larger aircraft will impose larger short run marginal costs. The A380 will require more parking space, and where space is at a premium in an airport, this will have an obvious opportunity cost.
However, a substantial proportion of the costs which need to be incurred to accommodate the A380 will take the form of sunk costs with low or negligible subsequent operating costs. Some airports will need to widen runways, and to realign taxiways so as to achieve adequate separations. These involve investments which, once completed, will not be required to be repeated. Once a runway is widened, the marginal cost of using it will be unchanged. This marginal cost or runway use is often taken to be around zero. This assumption has been challenged (see Hogan and Starkie, 2004), and it has been suggested that costs of runway damage could be significant. However, costs will be related to wheel loadings, not the size of the aircraft. Thus the A380’s marginal cost of runway use need not be very different from that of other large aircraft currently in use.
There are some estimates available of the costs of accommodating the A380. In the US, the General Accounting Office (GAO) has made estimates of the costs of modifying US airports to handle the A380 (GAO, 2002). It estimated that the cost of modifying Los Angeles International Airport would be $US1,215m (by far the highest cost), $US109m for Kennedy Airport in New York, and $US26m for Atlanta. Airbus disputes these figures on the ground that some of these expenditures would be incurred anyway, and are not purely A380 related. Their estimate is $US177m for Los Angeles, the same for Kennedy and $US25m for Atlanta (GAO, 2002, Appendix V). It is reported that £450m is being spent at London Heathrow Airport to accommodate the A380 (Rozario, 2004). Some of this is on terminal modifications, and would enable savings in expenditure elsewhere. These estimates suggest that the costs associated with modifying airports to handle the A380 can be substantial, but that they vary considerably from airport to airport. This expenditure will be necessary, in several cases, for a relatively small number of flights, at least for the next decade or so.
This raises the question of who should pay the costs of accommodating the A380. They could fall on:
The airlines which use the A380; or
Airlines in general, including the airlines which do use the A380.
A simple and popular answer would be that there should be user pays- i.e. that the airlines which use the A380 should pay for the upgrading of the airport to accommodate the aircraft. In competitive markets, these costs would be passed on to passengers, who also gain from the costs savings in using the A380.As with many simple answers, matters are more complex than they seem.
In this and the next two sections, it will be assumed that the objective is to promote efficiency in the aviation sector. This includes a short run dimension, namely that of ensuring efficient use of the airport facilities and aircraft which are present at a particular point of time. It also includes a long run dimension, namely that of ensuring that investments are only made when the benefits from them, such as in reduced aircraft operating costs, are at least as great as the costs of making them.
The short run efficiency problem involves getting the right mix of aircraft using an airport. Overall costs, including costs to the passengers, airline and to the airport, should be minimised. If the marginal costs imposed by all types of aircraft are the same, then airline costs (including costs of time and convenience to passengers) should be minimised. The long run efficiency problem involves ensuring that only those airports for which net benefits are positive make the investment in infrastructure to accommodate the A380. For some airports, investment is either clearly worthwhile or not worthwhile, though there are many in between these cases for which investment might or might not be worthwhile, and efficiency demands that these face incentives to make the right choice.
Where the introduction of the A380 involves increased operating costs of the airport, or opportunity costs of using scarce facilities and space, short run marginal costs will be positive. These types of costs are not too difficult to handle, since in general, it is efficient for users to be faced with the marginal costs which they impose. Thus it may be efficient to charge more for parking to an aircraft which uses more space. This said, there may be reasons for diverging from this rule if prices are not set optimally in the first place. To this end, the handling of short run marginal costs is considered in the context of airport pricing structures in the next section.
One issue concerns what allocative role prices should have. Prices have an obvious role in the short run- they will determine the use to which airlines make of an airport, and which aircraft they choose to fly into it. Prices also can be used as a signal for investment- the prices which the provider of the facility expects to receive will influence whether it will find an investment worthwhile. Prices will also condition the investment decisions of the airlines- if airports are charging more for A380s to use their facilities, airlines will buy and schedule fewer A380s.
However, prices need not be the only signal for investment. An airport which plans to not recoup the sunk costs from airlines which operate A380s can still undertake a cost benefit analysis to determine whether it is worthwhile (in overall efficiency terms) investing to accommodate the aircraft, and can choose not to accommodate if it is not worthwhile. Airlines will make their decisions whether to purchase the A380 based on whether the airports they wish to fly into can accommodate them. If airports do not invest to accommodate the A380, then airlines will purchase fewer of the aircraft. In short, prices may be used for the short run allocative problem, but alternative approaches may be used to resolve the long run investment problem.
IV Efficient Pricing and Investment Criteria In this section, it will be assumed that for an airport to be able to handle the A380, it will be necessary for it to make some capital investments, such as in widening the runways. These investments will be sunk costs in nature, and there will be no changes in operating costs associated with them. The marginal costs of an A380 in using these facilities will be the same as for other aircraft. For simplicity, the marginal costs of using the A380 will be taken as zero. Airports may have more than enough capacity, or they may be busy and congested or subject to excess demand.
When the Airbus A380 requires infrastructure which is in the form of a sunk cost and which entails zero marginal costs, it is efficient to have no specific additional charge for airlines when they use the A380 at an airport. Specific charges would discourage its use, leading to a loss of benefits, with no saving in costs.
However, there is a cost recovery problem- the costs of the new infrastructure must come from somewhere. Ideally this should be the least distorting source. Most airports operate to a (sometimes approximate) cost recovery target. Either they are publicly or community owned, and expected to cover costs, or they are privately owned but regulated such that revenues are just sufficient to cover costs. Specific government subsidies, which themselves would not be costless, are not likely to be provided for an upgrade in infrastructure.
Most airports operate with a charging system which relates the charges for an aircraft movement either to the weight of the aircraft or its passenger load. Larger aircraft, with less elastic demand, pay more than smaller aircraft. For airports with adequate capacity, this is a rough approximation to Ramsey pricing, and it imposes little dead-weight loss, especially since demand elasticities are generally very low (see Morrison, 1982). If charges are increased on all users to fund the infrastructure for the A380, the efficiency cost will be very low- very likely, much lower than the efficiency costs imposed by specific charges for using the A380.
Many airports are busy and have inadequate capacity. These airports are typically underpriced, and demand is rationed by slot mechanisms or congestion. Unless there is an efficient allocation of slots- a situation which is likely to be rare- an increase in airport charges will not come at any cost in terms of efficiency. Indeed, when there is congestion, a price increase will be efficiency enhancing (though this depends on the extent to which congestion is internalised- see Brueckner, 2002). In the case of busy airports, recovering the cost of the infrastructure for the A380 from users in general will be unambiguously the most efficient pricing policy.
So far, it has been assumed that simple unit pricing would be imposed. When there is a cost recovery problem, non linear prices, such as two part tariffs, are often more efficient. This possibility needs to be considered in the context of recovering the sunk costs of accommodating the A380.
One possible solution would be to offer a contract which involved airlines which commit to using the A380 making a contribution to the sunk costs, in advance, and for those which do so, zero specific charges for using the A380 would be levied. Other airlines, which do not contribute to the capital costs, would be charged a specific price when they use A380s at the airport. This solution would ensure efficient utilisation by airlines which contribute up-front, since they face the marginal costs of use- namely zero. Other airlines would face a charge for use, and would not use the A380 to its full potential. Thus there would be some cost in terms of efficiency in the short run, though it could be small, depending on what proportion of users paid up-front.
While, in principle, a two part pricing schedule has desirable properties, it may be difficult to determine the up-front contributions, especially when users are diverse with differing likely rates of using the A380. These might be on the basis of expected use of the aircraft, though this would result in some airlines making larger up-front contributions than others (and this might approximate a per-use charge). Alternatively, a fixed up front contribution might be charge, though this would discourage users which are below average in their use of the A380. As usual with two part tariffs, this fixed charge would discourage some users, and would thus have some efficiency costs.
Overall, the two part tariff is less efficient than the zero specific charge. This is unambiguously so in the case of busy airports facing excess demand, and probably so in the case of airports with ample capacity. The significance of the two part tariff in this context is not so much that it is the least distorting means of recovering costs (its usual advantage), but rather that it is a means of confronting the users of the A380 with the costs they impose on airports in a way that is not very distortionary.
(b) Investment Criteria
The long run decision for an airport is whether to invest to accommodate the A380. Suppose that welfare maximisation is the objective. Whether an airport invests will depend on the likely use of the airport by airlines scheduling A380s. If there is only likely to be limited use by airlines of the aircraft, accommodation will not be worthwhile. For some airports, such as London Heathrow and Singapore Changi, accommodation will be well worthwhile, since the A380 is likely to be used extensively. For many airports, it may or may not be worthwhile to accommodate- for these, there is the risk of inefficient decisions if excessive investments are made, or provision is not made when warranted.
Given the welfare objective, the appropriate course of action is to undertake a cost benefit analysis of accommodation, balancing the costs against the benefits that airlines and others may gain from the lower operating costs, greater availability of capacity (if relevant) and lower congestion (also, if relevant). For a slot limited airport, the use of the larger aircraft will make more slots available, which will be a benefit. If the additional infrastructure is provided, unless a two part tariff is feasible, the optimal specific charge for the A380 will be zero. In this context, there will be no role for prices in signalling how the airlines should invest in aircraft. However, availability of infrastructure will be the signal- some airports will not find it optimal to provide for the A380, and airlines will take this into account in determining how many of the aircraft to purchase.
For an overall optimum to be achieved, all the costs of the A380 need to be incorporated in the analysis. From the perspective of airlines, the costs of acquiring the A380 will need to be factored in - not just the cost of using it once it has been acquired (thus treating capital costs as a sunk cost). The price to the airlines will reflect the marginal production cost of the aircraft, plus a share of its development costs (see Section V below). If the decision to be taken is one of whether the A380 is to be produced or not, these development costs are relevant. However, once they have been committed- as they have been now- they are a sunk cost and only the marginal cost of producing the aircraft should be taken into account in cost benefit analysis of whether an airport should upgrade to accommodate the A380.
This combination of zero pricing and cost benefit analysis of investment will result in an optimal result, assuming airlines and aircraft manufacturers do not play a game with the airports. The prices chosen will optimise the use of the airport whether or not the investment has been made, and the use of cost benefit analysis will result in an efficient investment choice. To the extent that cost recovery is required, there will be a slight efficiency loss when prices to all users are raised a little, though this would be the least distortionary solution.
VPricing and Dynamic Inconsistency
While the characteristics of an optimal solution may be clear, it may not come about, due to the dynamic inconsistency problem. This comes about when users of the airport face sunk costs, and by incurring them, can induce the airport to invest to accommodate the A380. The airport will assess the investment on the basis that these sunk costs have already been incurred, and thus should not be taken into account in the cost benefit analysis of accommodation. These sunk costs can arise at two stages. The first is at the airline level, where airlines incur a sunk cost in purchasing the aircraft, and the manufacturer incurs the cost of producing this highly specific asset. The second stage is at the point of the decision to produce the A380 in the first place – to enable production of the A380 to take place at all, Airbus had to incur very substantial sunk costs in development and new facilities. The sunk costs facing the airlines are considered first.
Here it will be assumed that the airport’s objectives are to promote efficiency. While this need not be so in all cases, government and community owned airports are often urged to promote efficiency, and private airports are regulated in ways that ostensibly, if imperfectly, promote efficiency. At every point of time, the agency, in this case the airport, may make decisions which are optimal- it prices existing infrastructure optimally, and it evaluates investment in infrastructure taking account of all benefits and costs. The users of the infrastructure, the airlines, know that it will be acting in this manner. In spite of this, it is possible for the long run outcome to be non-optimal, and for there to be excessive investment in infrastructure to handle the A380, and for airlines to purchase more A380s than would be efficient.
This can be illustrated as follows. Suppose the cost of accommodating the A380 at an airport is A, a sunk cost, and that there are zero marginal costs associated with use. The sunk costs to the airlines associated with buying the A380 are D, and once it has been purchased, the airlines will gain a cost saving of B.
Granted that they do not pay for the infrastructure, airlines will purchase if
B > D (1)
If the airlines have committed to purchase, the airport makes the decision on whether to accommodate on whether the gains from using the aircraft exceed the infrastructure costs, i.e. if
B > A (2)
However, from an overall welfare perspective, the investment in the aircraft and associated infrastructure is only worthwhile if
B > D+ A (3)
Clearly it is possible for (1) and (2) to be satisfied but not (3), and for it to be worthwhile for the airlines to purchase, and the airport to accommodate once the airlines have purchased, yet not worthwhile overall for the aircraft to be used.
This problem comes about essentially because the airlines or manufacturer play a game with the airport. The game could be considered as one between a single airline and airport, or it could be considered as one between airlines in general and airports in general.
Both airlines and airports must make decisions to incur sunk costs. The airlines must choose whether to purchase A380s or smaller aircraft. Once the aircraft had been purchased, it will be costly to switch types, since the sunk costs of constructing the chosen aircraft have been incurred, but the sunk costs of the alternative have not been incurred. If they purchase smaller aircraft, no further investment in airport infrastructure will be needed. If the A380 is purchased, additional infrastructure will be required, and this will involve the airport in incurring a sunk cost.
If the airlines choose the A380, they know that the airports will not impose any specific charge for this type of aircraft, because this would result in less than optimal usage. They do not know whether the airports will upgrade to handle the A380 however. The airports will undertake a cost benefit analysis. If the airport does a cost benefit analysis knowing that the airlines have committed to the A380, it is very likely that the cost benefit analysis will indicate a positive net benefit from upgrading, since if this does not go ahead, it will be necessary for the airlines to incur further costs in purchasing smaller aircraft – this could be an expensive option. The airports then find it worthwhile to upgrade, and the airlines’ gamble in choosing the A380 will have paid off.
In some cases, it will be efficient for the airports to upgrade to accommodate. However, there will also be cases where it would not be efficient. While it will be efficient to upgrade if the A380s have already been purchased, it would not be efficient if there was still the option of choosing either the A380 or smaller aircraft. By locking themselves in to the A380 purchase, the airlines have induced the airports to make investments which they not make if the sunk cost in aircraft purchase had not already been made- the benefits to airlines of choosing the A380 fall short of the costs to the airport.
The problem arises because there are two groups both incurring sunk costs. One group incurs a sunk cost which then forces the hand of the other, making it worthwhile for it to incur its sunk cost. If airlines and airports made the decision to purchase the A380 and invest in airports to accommodate it jointly, this problem would not occur. However, in reality, decisions are taken separately.
It might be objected that, from an individual airline’s viewpoint, the purchase of an aircraft is not a sunk cost, since it can still on-sell the aircraft if it finds that it is not using it. However, if airlines as a group over-order an aircraft, and then find they cannot use it as extensively as thought, then a sunk cost has been incurred. The lease price for this aircraft will fall, and the lease price of other aircraft will rise. In this situation, the airport, when determining whether to invest to accommodate the larger aircraft, will recognise the lower lease costs of the larger aircraft, and the higher costs of using smaller aircraft in its cost benefit calculations. The construction cost of an aircraft is very much a sunk cost. If the wrong type of aircraft is produced, it cannot be converted into the right sort. The presence of hundreds of idle, though serviceable, aircraft in the Mojave desert, at a time when hundreds of new aircraft are being produced by manufacturers, is indicative of this. For the air transport industry, an aircraft is a sunk cost, even if it is not for an individual airline.
Overall, there is the possibility of excessive investment accommodating the A380. If this game is played by airlines, there will still be many airports which do not accommodate- given their traffic; there is clearly no point in doing so. There will be other airports for which accommodation is clearly the efficient choice. However, in between these cases, there will be many airports for which accommodation is not worthwhile taking the long run perspective, but which will accommodate if airlines have already committed themselves extensively to the new aircraft.
The other stage at which sunk costs are incurred is in the development and production of the aircraft itself. Airbus has committed very large sums, in the form of sunk costs, in creating the A380. Firstly, the development costs are sunk. However, in addition, Airbus has had to invest heavily in specific facilities to enable the aircraft to be produced. While some of these facilities could be used for production of other aircraft types were the A380 not to be produced, Airbus would not have committed to build these (very large) facilities if the A380 was not expected to be produced. Airbus expects to recoup these sunk costs when it sells the aircraft. This implies that the price the airlines pay for an aircraft will be above its marginal cost of production.
In committing to the project, Airbus made estimates of likely sales. These in turn depend on whether airports invest to accommodate the aircraft, and the prices which airports charge. It may have bet that airports would not levy specific charges for the use of the A380, and that the purchasers of the aircraft would not be faced with the cost of the infrastructure to accommodate it. It may have implicitly assumed that airports would undertake cost benefit studies of accommodation and that they would take the costs of developing and preparing for the production of the A380 as an already sunk cost. Thus, the airports, when undertaking an evaluation of accommodation, if they did factor in the capital costs of new aircraft, they would use the marginal cost of producing the aircraft, rather than the higher price which airlines pay for it. It is conceivable that it may not have been worthwhile for Airbus to develop the A380 if the airport costs fell on users, but that it was worthwhile assuming that the costs fell on other users of the airports.
Thus the dynamic inconsistency problem can arise at either or both stages. An assumption that airports would price optimally, and would not impose the costs of upgrading on the users of the A380, may have been made by Airbus, and may have been a factor in its decision to commit to the project. However, this decision has now been made, and the development costs have been sunk. The second stage involves determining how much use of the A380 airlines will commit themselves to, and determining how many airports should commit to upgrade infrastructure to accommodate it. This stage is currently being played, and there is the possibility that an excessive number of airports will be induced to invest, due to the dynamic inconsistency problem.
VI Conclusions There is a possible dynamic inconsistency problem associated with the introduction of the Airbus A380 aircraft. This could lead to a situation in which there is excessive investment in accommodating the aircraft at airports, and an excessive level of use of thei aircraft granted the costs it imposes. The problem comes about because of the existence of sunk costs in the infrastructure to accommodate the A30, and in the development of the aircraft in the first place, as well as when the airlines commit to purchase it. The sunk costs in infrastructure imply that it is efficient in the short run for airports not to impose any specific charges for using the A380. Thus the manufacturer and airlines do not face the costs of accommodating the aircraft at airports, and bet that once it has been developed, and airlines purchase it, the airports will upgrade to accommodate it. This will happen even if, taking into account the sunk costs in development and purchase, it may not be efficient to develop the aircraft in the first place, or use it for particular airports. The decision to develop has already been taken, and the costs have been sunk, but the extent to which he aircraft will be purchased and used has not. There is the possibility that more airports than would be efficient will invest to accommodate it once faced with the fact that airlines have committed to purchase it.
This problem comes about if the airports seek to maximise welfare at each point of time. There is the likelihood that the manufacturer and the airlines will act strategically, and commit to building or using the A380, and force the hand of some airports to invest to accommodate the aircraft, even though they would not have done so when taking into account all the relevant costs. In this situation, simultaneous achievement of short and long run efficiency is not feasible. The second best solution may well be for the airports to sacrifice some short run efficiency to provide better signals for investment. If a two part tariff, whereby likely users of the A380 contribute to the airport’s cost of accommodating the aircraft, in return for zero specific charges for using it, is feasible, it may well be the best option. The two part tariff would be used here not for its usual purpose, to achieve cost recovery at minimum efficiency cost, but rather, to get around the dynamic inconsistency problem.
References Barros, A and S Wirasinghe (2002) “Designing the airport airside for the new large aircraft”, Journal of Air Transport Management, 8 pp 121-127
Blanchard, O and S Fischer (1989) Lectures on Macroeconomics, Cambridge Mass MIT Press
Brueckner, J., 2002, ‘Airport Congestion when Carriers have Market Power’ American Economic Review, 92, 1357-1375
Doganis, R (1992) The Airport Business, London and New York, Routledge
General Accounting Office (2002) Airport Infrastructure: Unresolved Issues Make it Difficult to Determine the Cost to Serve New Large Aircraft. Report to Congressional Requesters, GAO -02-251, US GAO, Washington, February
Hogan, O and D Starkie (2004) “Calculating the Short-Run Marginal Infrastructure Costs of Runway Use: An Application to Dublin Airport”, in P Forsyth, D Gillen, A Knorr, O Mayer, H-M Niemeier and D Starkie, (eds) The Economic Regulation of Airports: Recent Developments in Australasia, North America and Europe, Aldershot, Ashgate
Holzschneider, M (2004) “Are airports fit for the next decade?- Integrating the new super jumbo in the world’s airport system”, mimeo, Dornier Consulting
Kydland, F and E Prescott (1977), “Rules rather than Discretion: The Inconsistency of Optimal Plans”, Journal of Political Economy, 85 (3) June pp 473-492
Morrison, S (1982) “Landing Fees at Uncongested Airports”, Journal of Transport Economics and Policy, XVI No 2 pp151-160
Rozario, K (2004), “Boarding the A380”, Jane’s Airport Review, September, pp27-29
I am grateful to Anthony Bell for helpful research assistance, and for helpful comments at the Australian Conference of Economists and from Paul Hooper and Cathal Guiomard. Any errors are my own.