Economics homework essay, January 13th

Klaus Ashorn

a)

The airline industry, the companies that produce aerial transportation services, is vital in
todays world. It links the world together, easing both business and leisure. However, all
of this convenience and possibility comes at a cost. Moving around nearly 3 billion
passengers per year in addition to around 30 million metric tons of cargo 1 emits large
quantities of CO2 to the atmosphere, which in fact account for around 2% of the overall
world-wide greenhouse emissions. These emissions not only cause health problems, but
they also contribute to global warming, and through that to a wide range of
environmental and social problems, such as rise in sea levels, increased instances of
natural disasters, and loss of biodiversity.
In economic terms this can be described as an externality, which means a market failure
that is caused by a consequence incurring to third party as a result of some activity. The
externality can be either positive or negative. More specifically, in the case of the airline
industry, it is the case of a negative externality of production. This is because the product
of the industry is aerial transport, and it is the production, which means flying, that
causes the emissions, not the consumption, i.e. sitting onboard the airplane while it flies.
It could be argued that in the case of renting aircraft to private individuals there is an
externality of consumption, but as that only constitutes an extremely minor part of the
entire airline industry, I shall not focus on it in this essay.
Figure 1

1http://www.iata.org/pressroom/pr/pages/2012-12-06-01.aspx

As can be seen from Figure 1, the MPC is lower than the MSC (which in practice indicates
that as air is a common access resource, there is no private cost in polluting it) resulting
in an overproduction of Qprivate-Qsocial of flights. This results in a welfare loss, as shown by
the red triangle in the diagram. The welfare loss represents the externalities, and the
externalities are comprised of the environmental damage discussed in the opening
paragraph and a few other factors. For example, the effects of noise pollution on those
living near airports can be surprisingly severe. Noise not only disrupts sleep, but it also
causes an elevated risk of strokes, coronary and cardiovascular diseases 2. Additionally,
the pollution to the areas surrounding the airport can cause an elevated risk of cancer 3 .
Compromised health will cause harm to the individual himself, and also to the society in
the form of decreased productivity and increased medical expenses. From the point of
view of the government, this situation is sub-optimal, and the government should
therefore seek to minimize the welfare loss.
b)
To begin analyzing the extent to which the government should take action, certain
aspects must first be discussed. It seems that when consumers are given the option, they
are not willing to pay more to compensate for their carbon emissions. An interesting
example highlighting this is a carbon emission off-set program by Qantas airlines. In this
program Qantas calculates the carbon emissions per person for each flight, and then
gives customers the option to pay the appropriate amount of money (regularly under 10
AUD) that will then be used to off-set the carbon emissions of that flight. Despite the
relatively low price, a 2008 report found that only less than 1% of customers opted to pay
this fee4. Therefore it seems that even educated consumers (whose portion is surely over
1%) generally do not pay the fee, and hence education does not seem to be a very
effective solution. In other words, consumers do not appreciate environmental
friendliness enough to warrant profit-seeking companies to spend enough money on it,
and hence the market is unable to solve the problem by itself. Therefore an outside body
needs to step in to set minimum standards (otherwise there will always be an airline
winning the customers by being able to sell cheaper tickets due to not spending money
on reducing emissions), and the government is in the best position to be this external
body.
Then the question becomes: to what extent should the government intervene, and which
methods should it use in intervening? In answering this question it is important that we
acknowledge that as the airline industry is vastly important for the society and has
2 http://www.theguardian.com/science/2013/oct/08/aircraft-noise-pollution-heart-diseasestroke
3 http://www.dailymail.co.uk/health/article-17419/Now-living-airports-cancer.html
4 http://www.appropedia.org/Carbon_offsets_in_Australia

numerous benefits, such as tourism, cargo, and direct and indirect employment by the
airline companies and their sub-contractors, simply shrinking the industry should not be
the goal. There has to be a balance between the good sides and the bad sides; a certain
level of environmental damage is acceptable if it leads to sizeable benefits in other areas.
Thus there are two main categories of policy that the government might utilize in solving
this problem: 1) policies to encourage more environmentally friendly air travel 2) policies
that force airline companies and consumers to pay a fee to partly off-set their emissions.
First, the government could attempt to promote more environmentally friendly air travel.
This means encouraging airline companies to invest in newer and more environmentally
friendly fleets. In practice, the government could provide incentives, like tax breaks and
subsidies, for airline companies to replace older airplanes with newer ones, or it could
collect carbon taxes. Modern aircraft can be up to 20% more fuel-efficient than slightly
older ones that are still widely in use 5, so the effect could be significant. Additionally, the
government could, with the aid of education and subsidies, encourage the use of
substitutes, such as trains, for shorter flights. However, there remains a question: why
wouldnt the government set a law that obliges airlines and airline passengers to, at least
partly, off-set their emissions? The standard answer is that that would increase the price
which in turn would shrink the market so much that this should not be done considering
all the good sides of the industry. This claim, however, is unsubstantiated. To off-set half
of the carbon emissions of a London-Hong Kong-London flight, the cost would be around
60HKD if shared between the consumer and airline company 6. This is only around 1% of a
typical ticket (6000HKD), and is nowhere near enough to compromise demand. This could
be done through setting a tax on the carbon emissions, and it could be especially
effective as it would both incentivize cutting emissions and generate revenue for the
government that could be used for the carbon off-setting programs.

Figure 2

5 http://www.boeing.com/boeing/commercial/787family/programfacts.page
6 http://www.climatecare.org/home.aspx

As shown in the diagram, a carbon tax would move MPC to the left and closer to MSC,
reducing the welfare loss due to emissions as well as emissions themselves.
In conclusion, the government should take an active role in controlling the airline industry
through public policy, since the market itself clearly is not capable of fixing the problem
of environmental damage. The reality is that the airline industry will continue to grow in
the foreseeable future78910, so instead of fighting a lost battle against air travel itself, the
government should concentrate its efforts into making air travel less harmful for the
environment. It should pursue this goal by a combination of cutting emissions by
7
http://www.faa.gov/about/office_org/headquarters_offices/apl/aviation_forecasts/aerospac
e_forecasts/2012-2032/media/2012%20FAA%20Aerospace%20Forecast.pdf
8 http://www.iata.org/pressroom/pr/pages/2012-12-06-01.aspx
9 http://www.boeing.com/boeing/commercial/cmo/
10 http://www.eurocontrol.int/sites/default/files/content/documents/officialdocuments/reports/201306-challenges-of-growth-2013-task-4.pdf

encouraging the use of more efficient airline fleets, as well as countering the effects of
the existing emissions by high-quality carbon off-setting programs.

Sources:
IATA International Air Transport Association:
http://www.iata.org/pressroom/pr/pages/2012-12-06-01.aspx;
Eurocontrol: http://www.eurocontrol.int/sites/default/files/content/documents/officialdocuments/reports/201306-challenges-of-growth-2013-task-4.pdf
FAA Federal Aviation Authority:
http://www.faa.gov/about/office_org/headquarters_offices/apl/aviation_forecasts/aerospac
e_forecasts/2012-2032/media/2012%20FAA%20Aerospace%20Forecast.pdf
Boeing: http://www.boeing.com/boeing/commercial/787family/programfacts.page;
http://www.boeing.com/boeing/commercial/cmo/
Climate Care: http://www.climatecare.org/home.aspx
The Guardian: http://www.theguardian.com/science/2013/oct/08/aircraft-noise-pollutionheart-disease-stroke
Dailymail: http://www.dailymail.co.uk/health/article-17419/Now-living-airports-cancer.html
Appropedia: http://www.appropedia.org/Carbon_offsets_in_Australia
Skyscanner (for reference values of flight prices): skyscanner.com