Thursday, December 24, 2009

New rule on airline waits is a big win for consumers

Boston Globe editorial "New rule on airline waits is a big win for consumers" (December 24th, 2009)lauds a Department of Transportion ruling but fails to explain the intuition behind why regulation might increase efficiency, a phenomenon recherché enough to require explanation. Indeed, further examination suggests that the Globe has little reason to cheer.

About 1,500 times a year, airplanes have to wait more than three hours before a takeoff or cancellation of the flight. Such delays affect about 114,000 passengers. In many cases, crews run out of food and drinks for the passengers, and toilets fail. The new rules will also require airlines to provide snacks and drinks after two hours. Airlines that violate the president’s policy will have to pay fines of $27,500 per passenger.

That is more than a wrist slap and will likely push airlines into changing their schedules to reduce chances of extended delays. So be it. Passengers would be happier with schedules that are thinner but more manageable even when weather conditions throw a monkey wrench into operations.

Normally, the Globe's editorial would not be reason to celebrate. However, if there exist customers with heterogeneous preferences for waiting on the tarmac, it is possible that an airline's choice of quality is inefficient for the average customer, while being efficient for the marginal.

Specifically, an airline chooses price and quality to attract the marginal customer.  There is nothing that guarantees that the marginal consumer is a representative consumer.  If the schedule for a marginal consumer's valuation of quality slopes downward, we expect quality to be inefficiently low.  If it is increasing, we expect quality to be inefficiently high.

While this is a possibility, it is unlikely. Multiple airlines can provide a separating equilibrium in which multiple levels of quality are offered. Indeed, the existence of budget airlines make us expect that government regulation will unambiguously reduce utility of everyone involved.  The example of a separating equilibrium for quality is graphically displayed below (click to enlarge).

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