Air transport subsidies for resident passengers: The unexpected effects on competition

Abstract

Subsidies for resident passengers aim to promote air connectivity in remote areas. The European Union allows these subsidies to passengers living in European outermost regions and other specific regions. This paper analyses the effects of this kind of subsidies on the ticket price and level of competition. If there is no competition in the market, the monopoly airline increases the ticket price to capture part of residents’ subsidy and, thus, non-residents will be worse off. However, when the regulator raises the amount of the subsidy, there may be an unexpected effect on competition: a potential entrant may find the entry profitable, spurring competition and air connectivity. With competition, the non-desirable effects of granting a subsidy only for residents are mitigated. However, this latter case is only possible if the proportion of resident passengers in the route is high enough.