On the effects of airport capacity expansion under responsive airlines and elastic passenger demand

This paper investigates the effect of airport expansion on air traffic and its implications on airport congestion, airline competition and the social welfare, considering various airport administrative regimes (i.e., profit-maximization, social welfare-maximization, and budget-constrained social welfare-maximization), airline market structures (i.e., perfectly competitive, oligopoly, monopoly, leader–follower), and passenger demand patterns (i.e., regard airlines as perfect substitutes or imperfect substitutes). We develop an analytical tri-level model to examine the air traffic equilibrium in the airport–airline–passenger system, the effect of airport capacity expansion on the traffic equilibrium, and the decisions of different stakeholders. Specifically, we examine the airport’s decisions on capacity investment and airport charge in the first level, airlines’ decisions on flight volume and airfare in the second level, and the passenger choice equilibrium in the third level. The analysis in this paper suggests that (i) airport capacity expansion may induce the airline market to over schedule flights which leads to a more congested airport (i.e., capacity paradox); (ii) with a given airport charge, the capacity paradox is more likely to occur in an airline market with fewer competitive airlines; (iii) given the same airport capacity and traffic, the capacity paradox is more likely to occur when the airport operator’s objective is social welfare-maximization (compared with profit-maximization and budget-constrained social welfare-maximization); (iv) airlines with market power will internalize a portion of airport congestion based on their market share, while a leader airline with the knowledge of the follower’s response will scale up or down their airfare in order to maximize its profit; (v) under different market structures, increasing airport charge always reduces the aggregate traffic volume when the airport capacity is fixed.