Question

1. York Airlines offers three classes of service on their flights between Toronto and Van- couver: economy, premium economy, and business class. Andrew, a student, is willing to pay a maximum of $300 for an economy class ticket, but is willing to pay up to $100 extra to travel in premium economy or in business class. Rebecca, a successful CEO, is willing to pay up to $500 for an economy class ticket, $800 for a premium economy ticket, and $1,000 for a business class ticket. For simplicity, suppose that York Airlines marginal costs are negligible (it has to pay a fixed cost to fly the airplane, but there are no marginal costs per seat sold, regardless of the class of service), so the management of the airline simply wants to maximize revenues. (a) If the airline could perfectly price-discriminate, what class of service, and at what price, would it offer to each of the travelers? What would be the airline's total revenues in such a case? (b) Now suppose that the airline cannot perfectly price-discriminate; they must offer tickets in all classes of service to all customers, and tickets in a particular class of service must be sold at the same price to all customers. Suppose that the airline management decides to charge $300 for economy class tickets, $399.99 for premium economy tickets, and $1,000 for business class tickets. What kind of ticket will Andrew purchase? What kind will Rebecca purchase? What are York Airline's total revenues?

Answer 1

Answer 1 :

a) Price discrimination scenario :

In case of price discrimination, airlines will offer premium economy class to Andrew at $400. In this way they will be able to generate maximum amount from Andrew which he is willing to spend.

For Rebecca, airline will offer business class at price of $1,000.

In this case airline will be able to obtain maximum revenue through both of these travellers which will be : $400 + $1,000 = 1,400.

Answer 2 :

b) No price discrimination scenario :

Andrew will purchase premium economy ticket only in this case because he is ready to spend $100 extra on economy class ticket if he gets premium economy in that price. As airline is offering premium economy at price of $399.99, so Andrew will purchase premium economy ticket.

Rebecca will purchase business class ticket. As airline is offering business class ticket at $1,000 and Rebecca is already ready to spend the same for it hence she will purchase business class ticket.

Total revenue for airlines would be : $399.99 + $1,000 = 1,399.99