Write an essay titled “Is there price discrimination in the US Airline Industry?

Question

Write an essay titled “Is there price discrimination in the US Airline Industry?” In preparing your essay please address the following questions: 1. Which general conditions need to exist in a market for price discrimination to be possible? (use McAfee). 2. How do carriers price discriminate? Mention at least three methods of price discrimination (use Steen and Sorgard). 3. Variation in prices may either be due to price discrimination practices or may simply be a result of variation in costs. Explain how it can be tested whether price dispersion is a result of price discrimination? (use Borenstein and Rose 1994, Section III). 4. What is the relationship between market structure (i.e. level of competition) and price discrimination? (use Stavins 2001) Your response should be typed and between 1 and 2 pages long (single spaced, Arial 11pt font).

Explanation / Answer

The term ‘Price discrimination’ may be defined as a practice of charging different price for same commodities from different consumers. i.e. for the same product, lets say railway ticket, that seller is charging more price from people between age group 12 to 60 and less from children below 12 and the elderly above 60 years of age. Price discrimination strategy is adopted when the producer has some monopoly power. Using that monopoly power the seller of the product charges different price from different categories of consumers with different characteristics or belonging to different groups.

There are three degrees of price discrimination. The first degree depends on the willingness of the consumer to pay for the product, the second degree depends on the grouping or the categorization of the consumers and the third degree is based on difference in price elasticity of demand for the same product in different markets.

Yes there is price discrimination in the U.S. Airline industry.

1. According to Preston McAfee, price discrimination is based on difference in elasticity i.e. the seller can charge less price from the market where price elasticity of demand is more and can charge more price where elasticity of demand is less. The condition for price discrimination to be successful are that there is no scope for arbitrage i.e. the buyer should not be able to buy product from the market where price is less and sell the same in the market where the price for the same is high.

In case of U.S. airline industry, it charges high price for people travelling in business class and low price for people travelling in economy class. Also they charge low price for ticket bookings made in advance and high price for ticket bookings made in emergency. There are various factors that prevent arbitrage in airline industry i.e. contracts, custom-made services, high costs of transportation, legal regulations, prohibiting resale, specific customer segment, limited availability of customers and lack of information thus airline carriers have enough monopoly power to practice price discrimination.

2. Steen and Sorgard have identified three types of price discrimination practiced in Airline industry i.e.

a. Price discrimination based on quantity of tickets purchased, for example on purchasing bulk tickets quantity discounts may be offered;

b. Price discrimination on frequency of taking flights, for example a frequent flyer may be given discount

c. Price discrimination on the quality of transport services like Versioning for example the high price for tickets with which the buyer gets the options available for postponing, proponing or cancelling of tickets.

3. Variation in prices may either be due to price discrimination practices i.e. seller’s willingness to receive additional profit or may simply be a result of variation in costs. Borenstein and Rose have identified various self-selective discriminations in airline industry based on heterogeneity of the product or the dependence of costs on flight parameters (day of week, time, number of stops, etc.). Two major sources of genuine cost variations are systematic peak-load pricing emerging from the uncertainties of demand for airline tickets and stochastic load pricing based on the existing demand.

Signals of price discrimination are the differences in receptiveness to market competition for diverse kinds of prices offered by the same airline carrier. The increase in price spread with the concentration indicates monopoly-type price discrimination and decrease in price dispersion decreases with concentration indicates competitive-type price discrimination.

Other issues motivating price discrimination are modification of customer characteristics, market density and market positions of airline carriers based on size, market share, density of flights, etc. Characteristics of products affecting elasticity of demand also influence price discrimination.

4. Stavins has confirmed the relationship between market structure (i.e. level of competition) and price discrimination. The investigation of price discrimination possibilities and limitations used for price discrimination such as discounts offered on air tickets booked in advance or a Saturday night stay-over requirements shows that lower airfares are linked with greater restrictions, but directions with higher market concentration for specific air carriers are related to lower discounts.

To conclude we can say that there is prominent price discrimination in the U.S. airline industry with three key price discrimination types – versioning, discounts for large customers and loyalty bonus programs. The use of price discrimination becomes more intensive with increase in market competitiveness.

Related Questions

Navigate

• Browse (All)
• Browse W
• Subjects

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.