Price-cap Regulation of Airports: Single-till Versus Dual-till

Abstact This paper takes up the debate whether price-cap regulation of airports should take the form of single-till or dual-till regulation. The contribution is to model single- and dual-till regulation, evaluate their welfare implications, and compare them to Ramsey charges. We show that single-till regulation dominates dual-till regulation at non-congested airports with regard to welfare maximization. However, none of them provides an airport with incentives to implement Ramsey charges. A Ramsey optimal price-cap regulation, which achieves this goal, is also presented. Thanks to Kay Mitusch, Pio Baake, and Sascha Lukac for very helpful comments.     

Regulation, privatization, and airport charges: panel data evidence from European airports

This paper examines the determinants of airport aeronautical charges by employing a unique panel dataset covering sixty-one European airports over an eighteen-year period. We are able to extend the literature on the role of airports as an essential element in transport infrastructure by offering the first analysis of the impact of different regulatory policies and privatization on airport charges in a panel data setting where fixed effects can be employed to mitigate endogeneity concerns. Our main empirical results indicate that aeronautical charges are lower at airports when single-till regulation is employed, when airports are privatized, and??tentatively??when ex post price regulation is applied. Furthermore, hub airports generally set higher aeronautical charges, and it appears that price-cap regulation and the presence of nearby airports do not affect aeronautical charges.     

Asymmetric equilibria under price cap regulation

This study analyzes the effects of a price-cap regulation on market outcomes in Cournot and Stackelberg duopolies. Although two firms are ex-ante identical, there are asymmetric Cournot equilibria as well as the symmetric equilibrium under the price-cap regulation, when the price-cap level is binding. By contrast, the Stackelberg equilibrium is unique and equivalent to the most asymmetric Cournot equilibrium under a binding price-cap level. We present several comparative statics results with respect to the equilibrium outcomes. The main concern of this study is the welfare effect of a change in a price-cap level. We show that when asymmetric Cournot equilibria or the Stackelberg equilibrium are focused on, a reduction in a price-cap level may be socially harmful even if the price-cap level is more than the competitive price.     

Price Regulation for Independent Transmission Companies

This paper considers methods of price structure regulation of electricity transmission in the context of an independent transmission company (TRANSCO). The focus is on two-part tariffs where the variable part would reflect congestion charges (and ancillary services) while the fixed part would reflect capacity costs. The two-part tariffs form a price-cap index, and the firm could rebalance prices, as long as the index satisfies the price-cap constraint. The firm would then have incentives to trade off congestion against capacity expansion in such a way that it becomes profitable to expand, whenever the costs of congestion on average exceed the costs of expansion. However, with chained Laspeyres weights in the price-cap index expansion may be suboptimal. We therefore discuss ways to improve the expansion factor. Implementing the regulatory schemes considered suggests a hybrid approach combining a TRANSCO with an independent system operator (ISO).     

Welfare Consequences of Tight Price-Cap Regulation

This paper analyses the welfare effects of price-cap regulation of a multi-product monopolist when the price index has fixed weights. A tight cap can result in welfare below the level associated with an unregulated monopoly. This does not occur if the weights are based on lagged quantities and the level of the cap exceeds the previous period's total cost. In a two-period model the welfare problem is alleviated in the second period but first-period performance can be worse if the firm is not myopic.     

Price vs. quantity-based approaches to airport congestion management

This paper analyzes price and quantity-based approaches to management of airport congestion, using a model where airlines are asymmetric and internalize congestion. Under these circumstances, optimal congestion tolls are differentiated across carriers, and a uniformity requirement on airport charges (as occurs when slots are sold or tolls are uniform) distorts carrier flight choices. Flight volumes tend to be too low for large carriers and too high for small carriers. But quantity-based regimes, where the airport authority allocates a fixed number of slots via free distribution or an auction, lead carriers to treat total flight volume (and thus congestion) as fixed, and this difference generates an efficient outcome as long as the number of slots is optimally chosen.     

AIRPORT CONGESTION PRICING AND ITS WELFARE IMPLICATIONS: THE CASE OF VARIABLE PASSENGER TIME COSTS

This paper develops an analytical framework for airport congestion pricing by considering variable passenger time costs. We find that, first, congestion delays will not be fully internalized at the carrier level under different market structures, including those airports dominated by a monopoly airline. Therefore, congestion pricing is necessary regardless of the market structures. Second, although congestion pricing is welfare‐improving, it may not be Pareto‐improving. This might explain why congestion pricing is unpopular in the real world.     

Rent extraction and incentives for efficiency in recent regulatory proposals

Building on a simple model proposed by Schmalensee (1989), this paper uses simulation techniques to analyze and compare various regulatory schemes including Schmalensee's family of (linear) good regulatory regimes, a price-cap regime allowing for downward price flexibility, and a regime that combines price-cap and profit sharing. The quantitative analysis pays particular attention to measuring the trade-off between rent extraction and incentives for efficiency. The main findings of this study can be summarized as follows. First, it appears that pure price-cap regulation leaves substantial rent to the firm relative to the other regimes. Second, introducing room for downward price flexibility improves efficiency of price-cap over Schmalensee's linear regulatory regimes. Finally, by correcting in part for the distributional distortion of price-cap, the profit-sharing mechanism often yields levels of welfare comparable to optimal regulation levels.     

AIRPORT PRIVATIZATION AND INTERNATIONAL COMPETITION

We provide a simple theoretical model to explain the mechanism whereby the privatization of international airports can improve welfare. The model consists of a downstream (airline) duopoly with two inputs (landings at two airports) and two types of consumers. The airline companies compete internationally. We show that the outcome in which both airports are privatized is always an equilibrium, whereas that in which no airport is privatized is an equilibrium only if the degree of product differentiation is large. We also discuss airport congestion problems within the model framework.     

Setting the X Factor in Price-Cap Regulation Plans

Despite the popularity of price-cap regulation in practice, the economic literature provides limited guidance on how to determine the X factor, which is the rate at which inflation-adjusted output prices must fall under price-cap plans. We review the relevant basic principles, and then determine how to set the X factor: (1) when only a subset of the firm's products are subject to price-cap regulation, and when product-specific costs and productivity cannot be measured; (2) when changes in regulated prices affect the economy-wide inflation rate; and (3) in the presence of such structural changes as strengthened competitive forces.     

Pricing incentives under price-cap regulation

In many price-cap regulation plans, such as those of AT&T and British Telecom, a weighted average of the prices for multiple services (baskets) must not exceed a specified level. This analysis demonstrates that the weighting scheme most commonly employed is subject to intertemporal manipulation. This investigation provides specific demand conditions under which weight manipulation can arise, shows the manipulation to reduce social welfare, and proposes a simple alternative weighting scheme that is less prone to manipulation. The alternative weighting scheme can help in designing more effective price-cap plans, especially if new plans have longer terms than current ones.     

Price cap regulation: A case study of some pitfalls of implementation

There has been considerable discussion of price-cap regulation as an alternative to traditional rate-of-return regulation. This paper examines some of the practical pitfalls of price-cap regulation. First, a model of a terminating price cap is developed. Next, this model is used to propose some problems of implementation. These problems are evaluated in the context of a case study of the Tucson Electric Power Company, which faced a type of price cap for several years in the 1980s. Extensions of the specific case to more general lessons about price-cap regulation are considered.     

Congestion pricing of Canadian airports

Abstract Under congestion pricing, Canadian airports would annually save between $72 and $105 million. Social costs per landing and takeoff decrease about $300 at Toronto and Vancouver and $50 at Calgary and Montreal. Slot constraints fail to eliminate this airport congestion. Congestion prices are lower on average than existing weight‐based prices. Current airport capacity accommodates at least five more years of traffic growth before congestion reaches current levels. Substantial welfare gains occur even if dominant airlines already internalize their self‐imposed delays. This article calculates equilibrium congestion pricing schedules, traffic rates, queuing delays, layover times, and connection times by time of day.     

Price-Cap Regulation and Inefficiency in Relative Pricing

The allocative efficiency properties of three price-cap schemes are compared. The scheme that uses lagged quantities in the price index and has a fixed cap works well when the firm is myopic but generates inefficient relative prices otherwise. With myopia prices are efficient and welfare is higher than with equal pricing, but the gain to the firm comes at the expense of lower consumer surplus. When the firm is not myopic pricing can be so inefficient that steady-state welfare is below the no-regulation level.     

Customer ignorance, price-cap regulation, and rent-seeking in mobile roaming

Mobile phone usage when traveling abroad is expensive. Although the network connection switches frequently between available networks, the choice of network is largely independent of wholesale prices. As a consequence, we show that wholesale prices are strategic substitutes. The recent European price-cap regulation forces firms to reduce wholesale and retail roaming prices, but does not solve the underlying problem. There may thus be a permanent need for regulation analogous to what we have for domestic call termination. Furthermore, we show that there is a risk that wholesale price-cap regulation stimulates wasteful rent-seeking activity.     

Strategic pricing and entry deterrence under price-cap regulation

This paper shows that dynamic price-cap regulation allows the regulated firm to deter entry. Under dynamic price-cap regulation, the allowed prices in each period are an increasing function of the prices set in the previous period. By setting a low price before entry, the regulated firm can commit itself to charge a low price in the event of entry. If this price is sufficiently low with respect to the potential entrant's fixed cost, entry does not occur. Whether the regulated firm prefers to deter or accommodate entry depends on the level of the entry cost for the prospective entrant, on the tightness of the price-cap and on the degree of market power of the competing firms in case of entry.     

An empirical analysis of incentive regulation and the allocation of inputs in the US telecommunications industry

A translog cost function is estimated to examine whether carriers use an efficient combination of inputs in the telecommunications industry. Special attention is given to the role of rate regulation reform in an increasingly competitive business environment. Findings suggest that telecommunications carriers facing price-cap regulation do use an efficient mix of labor and capital. In contrast, the condition for cost minimizing use of inputs is not met for telecommunications carriers facing rate-of-return. The superior factor input use allocation by carriers facing price-cap regulation compared to carriers facing rate-of-return regulation is interpreted as suggesting that incentive regulation plays an important role in promoting efficient use of inputs even in a competitive business environment.     

Third‐degree price discrimination in the presence of congestion externality

This paper analyzes third‐degree price discrimination of a monopoly airline in the presence of congestion externality when all markets are served. The model features the business‐passenger and leisure‐passenger markets where business passengers exhibit a higher time valuation, and a less price‐elastic demand, than leisure passengers. Our main result is the identification of the time‐valuation effect of price discrimination, which can work in the opposite direction as the well‐known output effect on welfare. This time‐valuation effect clearly explains why discriminating prices can improve welfare even when this is associated with a reduction in aggregate output.     

Price-cap versus rate-of-return regulation

Rate-of-return regulation has been criticized for providing inappropriate incentives to regulated firms and for being costly to administer. An alternative is price-cap regulation, by which ceilings (caps), based on indices of price and technological change are imposed, below which the regulated firm has full pricing freedom. The differences and similarities of the two are reviewed herein in the light of recent literature. In practice, price-cap is not distinct from rate-of-return regulation. Especially for the multiproduct firm, information requirements—the ultimate source of problems with rate-of-return regulation—are comparables. Price-cap regulation fails to address the real regulatory issue of whether an industry is, in whole or in part, a natural monopoly.     

The relationship between the costs and prices of a multi-product monopoly: The role of price-cap regulation

This paper examines the role of price-cap regulation in influencing the relationship between the costs and prices of a multi-product monopoly. Based on a simple model of mark-up pricing, a combination of analytical and numerical analysis is used to show how cost increases among the firm's products can cause a divergence of prices from the Ramsey structure if the cost increases are non-uniform or if the demand elasticities for the products are non-uniform. However, in the absence of additional cost changes, profit-maximising prices which are subject to a price-cap constraint converge to the Ramsey structure if the previous period's quantities are used as weights in the firm's price-cap constraint. Consequently, given this formulation of the firm's price-cap constraint, only in situations of recurring cost changes are prices likely to show on-going divergence from the Ramsey structure.This paper reports on research funded by the Australian Electricity Supply Industry Research Board. I am grateful to two anonymous referees for their helpful comments on previous versions.