Optimal route allocation in a liberalizing airline market

Airlines often encounter two major problems in expanding their international networks: (1) restrictive Air Services Agreements (ASAs) governing airlines' commercial rights, and (2) slot / capacity constraints in foreign hub airports. Government interventions are needed to solve these problems, yet few quantitative models are available to guide the design of related public policies. This paper proposes a new model for optimizing the allocation of additional routes in a liberalizing airline market, in which airport capacity constraints are explicitly considered. The proposed model captures the interactions among three types of agents: (1) a regulator who aims to maximize social welfare by optimizing the allocation of additional routes to competing carriers; (2) airlines competing with flight frequency and airfare; and (3) passengers who minimize their own travel disutility (or equivalently maximize utility) given airlines' services and prices. In the proposed model, the passenger demand elasticity is also explicitly considered. The route allocation model is formulated as a 0-1 integer programming problem, and is solved by a heuristic implicit enumeration approach. The Korean - mainland China - Hong Kong airline market serves as model illustration. The effects of airport slot constraints are examined, and the revealed value (marginal welfare gain) of airport capacity expansion is also calculated, which can potentially serve as a benchmark indicator for the planning of airport investments.