12/29/2010

Airline flight cancelations: another cost of government regulations

How well does government balance off the costs and benefits of its regulation? I would argue not very well. Indeed, in the context of people getting upset about having to sit on airplanes, I would argue that there is no reason for government regulation. How much do passengers want to get to their destination? How upset are they by sometimes having to wait on the runway in a plane? How much does it raise the price of fares to have trips cancelled so as to avoid getting people stranded? Airlines compete against each other for passengers. Airlines compete on numerous dimensions, including avoiding having people stranded on runways. If the airlines don't get the tradeoffs on these dimensions right, passengers will fly on other airlines. To use economic jargon, there is no externality problem here. Fox News has the story here:

Charges have been flying that airlines prematurely canceled flights ahead of the East Coast snowstorm because of new rules fining airlines for leaving planes standing idle on tarmacs, though transportation experts say that such claims are impossible to quantify.
In April, new rules went into effect that threatened airlines with a $27,500 per passenger fine if their planes didn't take off within three hours after pulling out to the tarmac. The move was aimed at reducing a spate of horror stories from people stuck in claustrophobic conditions on planes without access to bathrooms, water or food.
The regulation seems to have had its desired effect. According to the Department of Transportation, since new rules were enacted in late April, the number of tarmac delays over three hours has dropped considerably. From May to September 2009, 535 tarmac delays over three hours were reported; in May through September this year, the number was 12.
But after an East Coast storm threatened to ravage New York area and other airports, hundreds of flights to and from the region were cancelled – several even before the snow started to fall -- and complaints are mounting that the airlines were deserting their customers for fear of racking up fines.
"There's no doubt about it, airlines (were) pre-emptively canceling flights because they don't want to be stuck paying $27,000 per passenger," said Vaughn Cordle of Airline Forecasts.
"I think it's safe to say that there are many passengers who would have reached their destination, albeit with non-trivial delays, had the ... ruling not be in effect," said Amy Cohn, an associate professor of industrial and operations engineering at the University of Michigan and an affiliate at MIT's Global Airline Industry Program. . . . .

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4 Comments:

Blogger Al B. said...

“Airlines compete on numerous dimensions, including avoiding having people stranded on runways. If the airlines don't get the tradeoffs on these dimensions right, passengers will fly on other airlines. To use economic jargon, there is no externality problem here.”

Airlines are, literally, in the business of moving meat (us). Casual travelers want to get from point A to point B as cheaply as possible. This is why airlines are able to over-book and allow people to fly ‘stand-by’. Casual travelers who fly infrequently would typically lack the information necessary to discriminate between airlines on any basis other than cost. And for most of us, paying extra for a less unpleasant experience is an expense we can’t afford anyway. However, if we had better information, such as the probability that our trip would turn into a quest, we might choose not to make that trip at all.

Business travelers are typically required by their companies to fly as cheaply as possible with the additional condition that they get where they need to be on-time. Their comfort is, to use economic jargon, an externality to the company that is paying for their flight.

Air travel is expensive, to the point where passenger comfort does indeed become an ‘externality’ both to the airlines and to whoever is paying the bills. The point is, airlines don’t have to provide good service; they just have to provide service that isn’t any worse than any other airline. An airline that provides better service at a higher price is an airline that is likely headed for bankruptcy. If this weren’t so, airlines would NEVER leave passengers sitting on the tarmac for 12 hours.

As your article pointed out, delays of more than 3 hours have dropped by more than an order of magnitude since the new regulation went into effect. Undoubtedly, this makes fares somewhat more expensive for everybody. Why? Because, when you are sitting in a hot plane far from the terminal with your bags already loaded onto the plane for several hours, you can’t leave! And you have no idea how much longer you are going to have to wait, so you couldn’t make an informed decision even if you had the opportunity. So the airlines have an incentive to hold their passengers captive as long as there is a possibility that they might actually complete the flight eventually.

How much is it worth to the airlines to behave this way? Well, the FAA determined that a Pigovian tax of 27,500 dollars per passenger was about right. I.e., the airlines would have to raise their fares by 27,500 dollars per passenger, amortized over all passengers (27,500 x delayed passengers/total passengers) in order to afford to eliminate this negative practice on their own. Since the number of delays over 3 hours still isn’t zero, the size of this fine is probably about right.

Undoubtedly, some passengers were left stranded by the storm who would otherwise eventually have gotten to their destinations. There were also probably many times more passengers who would have been stranded anyway, after spending many hours sitting in a cramped metal tube.

So, fares go up, fewer people fly, and the FAA gets fewer complaints. The people who do continue to fly benefit from the elimination of a nasty practice at the cost of somewhat higher fares. Those who fly frequently on company business really don’t care that it costs their companies more. Those who fly in order to visit grandma on Christmas have to decide whether or not the increased fare price is worth it. They will also have to evaluate the risk of getting stranded based on weather conditions; something that will be easier for them to do in the future. Everyone but the airlines benefits from the fact that the airlines can’t use their superior information about the likelihood of a flight being canceled as ‘efficiently’.

Think of it as a multi-party game without any obvious equilibrium.

12/30/2010 11:33 AM  
Blogger Al B. said...

This comment has been removed by the author.

12/30/2010 11:36 AM  
Blogger Al B. said...

This comment has been removed by the author.

12/30/2010 11:42 AM  
Blogger Al B. said...

Please excuse the multiple posts. Google kept saying that it was rejected because of length, so I kept shortening and re-posting it. I gave up after 3 attempts, but apparently they all did get through.

1/01/2011 10:21 AM  

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