Fostering the connectivity on thin routes: Should regional airlines cooperate with network airlines or with local governments?

This paper constructs two-stage Nash Bargaining models to examine two types of capacity purchase agreements (CPAs) for regional airlines: one with a local government and one with a network airline. The study compares the impacts of both CPAs on airline profits, consumer surplus, and social welfare. The results show that within a specific bargaining parameter range, both CPAs increase airline profits and net consumer surplus in small regional markets compared to the scenario without a CPA. However, these agreements may reduce consumer surplus in the trunk market. The social welfare levels under both CPAs are higher than in the case of no CPA. In comparison to the local government CPA, the network airline CPA results in lower profits for the network airline but higher profits for the regional airline. Additionally, the network airline CPA leads to lower consumer surplus in both the trunk and the regional markets, as well as reduced overall social welfare across the network. The model is further extended to incorporate flight frequency as a decision variable after CPAs are finalized. In this case, the network airline CPA can outperform the local government CPA in regional consumer surplus and network-wide social welfare when the regional airline faces high frequency-specific operational costs.