Allocative Efficiency and Cross-Subsidisation in Pricing
74. In general terms, the price for each good or service should be set where the marginal cost of supply equals demand, so that the ensuing quantity produced maximises allocative efficiency. The Commission has assessed to what extent the structure of prices for airfield activities are allocatively efficient, and whether there is any cross-subsidisation. It notes that, in the airfield activities context, setting prices to maximise allocative efficiency potentially encounters a number of difficulties, as follows:
- Efficiency requires that separate products are priced separately according to the marginal cost of supply. However, the administrative cost of having separate charges has to be taken into account, especially when the cost of each service is small. It might also be commercially impractical to measure each user's marginal cost and to charge accordingly. Consequently, an approach commonly adopted by airports is to set prices for a limited number of groups of users. The airports work out their total costs of airfield activities, and then allocate the corresponding revenue requirements across users according to a series of cost drivers. The resulting landing charges are computed largely based on the weight (MCTOW) of each aircraft, with the cost per MCTOW increasing through weight classes. This may not necessarily generate efficient prices, as there appears to be no attempt to integrate information about demand elasticities into price-setting. The Commission notes that international agreements limit the extent to which airports can apply efficient pricing.
- A characteristic of the cost structure of an airport's airfield activities is the high proportion of fixed costs. As a consequence, average cost is likely to be greater than marginal cost. As a result, setting efficient prices at marginal cost would produce financial deficits. The Commission considers that airports should be able to recover the total costs of airfield activities (both fixed and common costs), and, as a result, `first best' pricing would not be financially viable.
- Airports, because they offer a variety of services to a variety of users, have the potential through their charges to engage in cross-subsidisation. Cross-subsidisation can arise where individual users do not pay enough to cover the additional costs they impose on the provider, or where a service as a whole does not recoup its costs from users. Cross-subsidisation is economically inefficient, because some users contribute towards the cost of the services enjoyed by others, implying that prices diverge from marginal cost. A review by the Commission of the airports' pricing models and cost allocations has not identified any areas of cross-subsidisation.
75. A full discussion of issues regarding airfield pricing and cost allocation is provided in Chapter 7, and then these matters are discussed further in the airport-specific chapters.
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