5. Conclusions
This paper shows how an airline may adjust its pricing strategy in view of a market-based environmental policy within a competitive airline network. A portion of the induced environmental cost may be passed onto the passengers, resulting in increased ticket prices and lower demand. An empirical demand and supply model for air travel, which considers the interaction of passengers' behavior and airline decision, is presented. One important feature of this paper is that a carbon fee is introduced as a shifter of the airline's marginal cost. The adjustment of ticket prices in response to the carbon fee is determined by a Nash equilibrium in prices. The key determinants of airlines' demand and cost are identi- fied. On the demand side, apart from ticket price, arrival delays and indirect flights are found to negatively affect air travel demand. Furthermore, travel demand of a specific connection is found to be negatively affected by the presence of an alternative airport. On the other hand, an airline could increase its market share by improving its itinerary's frequency. Contrary to the majority of aggregate studies, which employ linear regression of passenger traffic, air travel demand is modeled by discrete choice models of consumer behavior. On the cost side, itinerary distance and fuel burn are the most significant cost drivers. The two-step Generalized Method of Moments is used for the joint estimation of the nonlinear model bypassing endogeneity issues through the use of proper instruments. One limitation of our analysis is that ticket price is considered as the key decision variable in the airline strategy towards an externally imposed environmental fee. In future research, additional decision variables considered by airlines such as frequency or hub choice location will be examined.
