Price discrimination is a strategy usually followed by a monopolist or even oligopolist where different consumers are charged different prices. Price discrimination can take three major forms, first degree price discrimination, second degree price discrimination and third degree price discrimination. In this paper we demonstrate how third degree price discrimination is practiced by the Airlines. We begin with a brief description of third degree price discrimination in the next section. In section III we discuss the methodology and data source of our research. In section IV we present the outcome of our research. Section V concludes the study.
Concept of Third Degree Price Discrimination
In third degree price discrimination different groups of consumers with different demand patterns are charged different prices . The firm divides its consumers according to their demand differences which is represented by the elasticity of demand. We often find discounts being offered to senior citizens and students who have lower purchasing power. In case of electricity we find that different tariff rates exist for residential, commercial and industrial consumers.
Third degree price discrimination is possible when the consumers can be identified as separate groups and when there is no possibility of resale of the product so that a consumer cannot buy cheap and sell dear to another consumer. Price discrimination can be feasible or profitable when the consumers have differing elasticity of demand .
The profit maximizing condition for third degree price discrimination is given as :
Where: MR1: Marginal revenue for consumer category 1
MC: Marginal cost of production.
Thus two conditions have to be satisfied under third degree price discrimination to ensure profit maximization:
The total output has to be produced till the point where the marginal revenue for each group of consumers equals the marginal cost of production.
The total output thus produced has to be divided among the different groups in a manner such that the marginal revenue of each group equals that of the other. The price has to be set accordingly.
This profit maximizing condition has been shown in figure 1.We see that the point where the MC cuts the MRT the total marginal revenue. The total output QT is divided into the two groups. Q1 and Q2 are the quantities sold to category 1 and 2 at prices P1 and P2 respectively.
In airlines third degree price discrimination is an usual practice. The business class travelers have a lower elasticity of demand as they have a greater urgency for the travel and they don’t have an option to plan way ahead of the trip. The leisure travelers do not have stringency regarding date and time of travel. We usually find that Monday morning flights have higher fares than on other days and times. Sundays have quite low fares.
We have studied the fare structure of two different airlines, one low cost carrier the Southwest Airlines and a network carrier the American Airlines. The fares for a round trip from Wichita to Las Vegas for four different dates have been obtained from the websites of the respective airlines . We have taken one recent date February 15. The other dates are in the following weeks, 22nd, 29 of February and 1st March. All the days chosen are Mondays. The reason behind choosing days a week ahead of each other is to distinguish the fares offered to the business class from that of vacationers. The business class travelers usually have a greater urgency for the travel on a particular date. The leisure travelers usually plan the trip way ahead to get a better bargain.
We present the outcome of our study in table 1. We observe that for the low cost airline the Southwest Airlines the airfares are lower than American Airways for all the four days being reviewed. For Southwest Airlines the fare is lower, further the date of journey is from the current date. Thus the price for February 15 is $762 whereas it is only $252 for February 29 and $262 for March 7.
For American Airlines also we observe the same pricing structure. The nearest date has the highest fare. Thus the fare for February 15 is $1109 whereas it is only $775 for February 29 and March 7. Thus we conclude that third degree price discrimination is a prominent feature of pricing in the airline sector. Since the vacationers book their ticket way ahead and have a higher price elasticity they have lower price to pay. The businessmen travel frequently at shorter intervals and have highly inelastic demand. So they face higher price of air tickets.
In this study we have observed the sir fares of two major airlines one a low cost airline and another large network operator. For both the airlines we have found distinct evidence of price discrimination being followed. Our study reveals that price discrimination is a feature of airline pricing.
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Southwest Airlines, 2016. Southewest Airlines. [Online] Available at: https://www.southwest.com/flight/shortcut/select-flight.html?outboundMonth=3&inboundMonth=3&selectedOutboundDate=&selectedInboundDate=[Accessed 13 February 2016].