Economics Assignment 1: Third-Degree Price Discrimination in Aviation

This economics assignment analyzes how airlines implement third-degree price discrimination, a strategy where different prices are charged to different market segments for the same service. The report begins with an explanation of the theory using a graphical model and then applies it to the airline industry. The student investigates how airlines differentiate prices based on factors like booking time and passenger type (business vs. leisure). The assignment presents a hypothesis that business travelers have a lower price elasticity of demand compared to leisure travelers. It includes a data table comparing fares from Delta and JetBlue for a specific city pair, examining how prices vary with booking time. The analysis concludes that airlines use advance purchase rebates to discriminate between leisure and business passengers and considers the impact of congestion costs on overall fares. The report references relevant academic sources to support its claims.

Running head: ECONOMICS ASSIGNMENT 1
Aviation Advanced Economics
Name of the student:
Name of the University:
Authors Note:

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Introduction
Third degree price Discrimination entails charging prices differently in various market
segments for similar services or products. In other words the theory of third degree price
discrimination has a direct link to the overall ability and willingness for the consumers to pay
for a particular service or goods. Under third degree price discrimination the cost of
production have limited relationship with the total price charged on the customers for a
particular service (Czerny and Zhang,2015).
From the graph below, price (Pa) is charged in the peak market and production takes place
at a point where MRa = MC (Berry and Jia, 2010).
Also, price Pb is charged in the off the peak market and production takes place at a point
where MRb = MC. It is important to note that a relatively high price level (Pa) is charged on
consumers that are inelastic in demand and those are elastic in demand are charged Pb due
to the high level of responsiveness.
Figure1 explaining third degree price discrimination (Berry and Jia, 2010).

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How airlines actually practice price discrimination
In the airline industry, it is very clear that individuals that engage in the booking of tickets
which are without a weekend stay and near the travel date incur higher prices when
compared to others. This is due to the low elasticity of demand and schedules which are
inflexible. Lower fares are charged on customers who book tickets in advance due to high
elastic demand (Basso et al,2009).
The new Distribution capability was one of the new booking system for air tickets takes a
vast or large information prices on the profiles of customers or individuals in search for fares
on comparison sites for price prior carrying out any booking. The airlines are interested in
offering various options for pricing to customer’s pr passengers in wide seats and in flight
movies. Option details like frequent flyer participation, leisure trip, business trip, travel

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history, age, nationality, marital status, shopping history and others are some of the options
enshrined in the booking seats (Bilotkach and Rupp,2012).
Airlines rely on detailed profiling to practice third degree price discrimination through
charging different customers for same routes but different fares. In other words where a
customer is interested on special meals, a particular seat any other facility, is made to spend
additional capital or money (Czerny and Zhang,2015).
Hypothesis
Business passengers have a less price elasticity of demand and exhibit a higher time
valuation when compared to leisure passengers (Bilotkach et al,2010).
Table showing the itineraries and fares for Delta Airlines New York, NY (JFK) -->Charleston,
SC (CHS) and JetBlue Airways New York, NY (JFK) –> Charleston, SC (CHS)
Delta Airlines New York, NY (JFK) -->Charleston, SC (CHS)
One day Fare =
$402.40
Return 9/12/17 at
11:13 am
Depart 9/5/17 at
8:15 am
One
week
Fare =
$372.40
Return 9/18/17 at
11:13 am
Depart 9/11/17 at
8:15 am
Two
weeks
Fare =
$282.40
Return 9/25/17 at
11:13 am
Depart 9/18/17 at
8:15 am
Four
weeks
Fare =
$455.40
Return 10/9/17 at
11:00 am
Depart 10/2/17 at
8:00 am
JetBlue Airways New York, NY (JFK) –> Charleston, SC (CHS)

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Discussion
From the
data
available, it
is clear that
the two
airlines
practice
third
degree
price discrimination where by different customers are charged different prices depending
on specific criteria like whether there travelling for business or for leisure. It is clear when
compared to leisure passengers, Business passengers in most cases engage in late flight
booking. Booking of flights late gives room to the airlines to use advance purchase rebates
to engage in third degree price discrimination between leisure passengers and Business
passengers. Due to the limitations in capacity passengers usually experience delays and at
the same time pay for a ticket. Congestion costs and ticket costs form part of the full fares
charged (Alderighi et al,2015).
Conclusion
Conclusively, third degree price discrimination is undertaken basing on specific criteria in
order to be able to obtain profits from the market basing on its underlying characteristics.
When carrying out price degree discrimination, the elasticity of demand of different
One day Fare =
$402.40
Return 9/12/17 at
10:20 am
7:38am
Depart 9/5/17
at
One week Fare =
$329.40
Return 9/18/17 at
10:20 am
Depart
9/11/17 at
7:25 am
Two weeks Fare =
$305.40
Return 9/25/17 at
10:20 am
Depart
9/18/17 at
7:25 am
Four
weeks
Am
Fare =
$410.40
Return 10/9/17 at
10:20 am
Depart
10/2/17 at
7:25 am

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passengers is put into considerations. Passengers with a high elastic demand are charged
lower price due to their high levels of sensitivity in demand while customers with inelastic
demand are charged higher prices. In this case passengers sensitive to price are made to pay
less than others.
References

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Alderighi, M.,Nicolini.M., and Piga,C. (2015). Combined effects of load factors and booking
time on fares: Insights from the yield management of a low-cost airline. The Review
of Economics and Statistics, 97, pp. 900-915.
Basso, L.J., M.T. Clements, and Ross,W.(2009). Moral hazard and customer loyalty programs.
American Economic Journal: Microeconomics, 1, pp. 101-123.
Berry, S. and Jia,P.( 2010). Tracing the woes: An empirical analysis of the airline industry.
American Economic Journal: Microeconomics, 2, pp. 1-43.
Bilotkach, V., Gorodnichenko,Y., and Talavera,O. (2010). Are airlines price-setting strategies
different?. Journal of Air Transport Management, 16, pp. 1-6.
Bilotkach, V. and Rupp.N.(2012). A guide to booking airline tickets online. In Advances in
Airline Economics: Pricing Behavior and Non-Price Characteristics in the Airline
Industry, Vol. 3, ed. James Peoples.
Czerny, A.I. and Zhang.A.(2015). Third-degree price discrimination in the presence of
congestion externality. Canadian Journal of Economics, 48, pp. 1430-1455.

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