Academic journal article The Journal of Social, Political, and Economic Studies

The WTC Emergency Airline Subsidies

Academic journal article The Journal of Social, Political, and Economic Studies

The WTC Emergency Airline Subsidies

Article excerpt

Following the September 11 crashing of two airplanes into the World Trade Center (WTC) by terrorists, the US government adopted a large airline subsidy with the apparent goal of preserving essential airline services. However, economic analysis shows that it is unlikely to achieve this goal because it leaves marginal cost and marginal revenue unchanged. Thus, it is unlikely to affect the level of airline service and unlikely maintain airline employment. In essence there was a large transfer of money to the industry for very little, if any, public benefit. A very generous victim assistance program was also adopted. No rational reason can be found for a program that assists these victims more than those killed or injured in other disasters.

Keywords: Airline subsidies, World Trade Center, terrorsim, economic role of government, market as allocator, trade unions, market self-regulation, victim assistance.

Very quickly after the September 11 crashing of two airplanes into the World Trade Center (WTC) by terrorists, the US government approved a large airline subsidy as part of an emergency assistance act (Public Law 107-42). This was rushed through quickly with little analysis of what needed to be done or exactly what goals were to be accomplished. This article will apply some standard economic analysis to this hastily adopted program. If the points made below had been understood by Congress, it is very likely the program would not have been adopted.

Subsidies are frequently attacked because of an economic theory that predicts that in a free market the output levels chosen by firms will be the Pareto optimal ones. Customers are presumed to adjust their expenditures so that the marginal utility they derive from each commodity is proportional to the price of the good or services consumed. It is also argued that firms set their output levels so that price equals marginal cost. Under these assumptions subsidies reduce total economic welfare. The distortion of prices produced by subsidies reduces overall welfare.

While the above is standard economic theory for perfect competition, the standard perfect competition model is inapplicable to the airline industry. It predicts that price will equal marginal cost. In turn, this implies that if marginal costs are equal, prices will be equal. This predicted price equality is absent. The airline industry is notorious for two passengers sitting in adjacent seats paying radically different prices. If one of these seats is priced at marginal cost, the other's price must differ from marginal cost. This is fairly clear evidence that the industry is oligopolistic.

Much of this pricing behavior arises from the difference between long run and short run marginal costs. The marginal cost of putting an extra passenger in an otherwise idle seat on a flight is quite low. This is why airlines are willing to sell seats they think would otherwise be empty for low prices. These are sold through discount mechanisms such as Internet sales, or with restriction designed to make them unattractive to business fliers (Saturday night stays).

However, if all seats were priced at such low levels, the fixed costs of flying the plane would not be covered and the airlines would constantly lose money. Hence the need to sell at least some seats at much higher rates, typically to businessmen.

The demand curve for seats on a particular route departing at a particular time has a rather steep slope. The airlines try to take advantage of this slope by charging high prices to those willing to pay them (typically business travelers) and lower prices to others.

The total area under the demand curve can be argued to give the total amount the consumers are willing to pay for access to that flight. However, the maximum revenue the airline can extract from the passengers is substantially less than the theoretical value of the service that particular flight offers. Leaving aside income distributional issues, this provides a well known theoretical argument for subsidizing airline services. …

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