As you know, airlines practice price discrimination by charging leisure and busi

Question

As you know, airlines practice price discrimination by charging leisure and business travelers with different prices. They could do so because of the different elasticity of demand between these two groups of travelers. Different customers pay varying prices for essentially the same coach seat because some passengers qualify for discounts and others do not. Since the discounts are substantial in many cases, the customer who qualifies for a discount pays a significantly lower airfare. Now, please answer the following question:

Is this consistent with profit-maximization? Given the current high cost of jet fuel, will you continue this practice? Why or why not? Please explain.

Explanation / Answer

The stated practice is inconsistent with profit-maximization.

Price discrimination is about charging the higher price to the customer segment who have a lower elasticity of demand, and lower price to customer segment with higher elasticity of demand. Now, elasticity of demand varies with income - customers with higher income tend to have inelastic demand and customers with lower income tend to have elastic demand.

In airline industry, discounts are normally offered to high-end airfare segment. So, such price discounts are lowering the price charged to the high-income, inelastic customer segment. This is in direct detriment to the principle of profit maximization.

Even though jet fuel cost is increasing, airfare price discrimination can be more profitable than single price strategy, if

- Seggregation of the different customer segments is properly done

- Elasticities of the different segments are correctly measured and computed, and

- Resale of tickets is not possible.

If these conditions are fulfilled, total revenue and total profit can be higher even though the high fuel cost may not justify a lower airfare to a great extent. Therefore, I would continue with price discrimination.

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