Discounts and Public Service Obligations in the Airline Market: Lessons from Spain

We examine the impact of the universal service policy that was applied to the Spanish airline market during the period 2001?C2009. Our analysis shows that routes that benefit from price discounts that were granted by the government to island residents enjoy higher demand than the rest of the country??s domestic routes. However, the lower elasticity of demand of these routes allows airlines to set higher prices. We also find that airlines that operate inter-island routes on which their services are regulated by price caps and frequency floors charge lower prices and schedule higher flight frequencies than is the case on unregulated routes. Overall, our analysis suggests that price discounts for island residents help guarantee the profitability of routes that are regulated by public service obligations.