Subsidies for resident passengers in air transport markets

In this work, we analyse from a theoretical perspective the efficiency of an ad valorem and a lump sum subsidy for resident passengers. In particular, we consider passengers with high and low willingness to pay that may be residents in a given area (and therefore entitled to a subsidy). All passengers are served by a monopoly air carrier that wants to get as much of their willingness to pay as possible. We show that if the proportion of resident passengers is high enough, non-resident passengers may be expelled from the market. Taken into account this undesirable situation we compare ad valorem and lump sum subsidies. We conclude that if the proportion of passengers with high willingness to pay is low (high) enough applying a lump sum (ad valorem) subsidy for resident passengers is better in social terms. We apply these results to a specific case study in the Canary Islands where ad valorem subsidies for resident passengers have been extensively used. We conclude that in most routes the lump sum subsidy is undoubtedly better in social terms.