Price Elasticity and Discrimination - Essay Example

?Sur Lecturer Price elasti and discrimination Price discrimination entails charging unlike prices to different groups of consumers for similar good. Airline businesses can charge unlike prices depending on various criteria: Quantity of ticket bought, for instance lower unit price is charged when more quantity is bought. Time of use-lower price at a lower peak and a higher price during peak times. The time the unit is bought, for instance discount is given for buying early. The major principle behind this price discrimination is that airline businesses are trying to utilize various price elasticities of demand (Holloway 25-29). In a market where travelers faces a highly inelastic demand, it implies for business, travelers are willing part with higher airfare price. Airline firm who can set elevated prices for these travelers can definitely increase their profits and revenue. However, other passengers will be highly sensitive to prices as they may face elastic demand. Therefore, this sort of passages will respond to special price discounts and offers. The airline firms can benefit if they can separate these different sorts of consumers and therefore decrease their consumer surplus. Price discrimination is common to most industries and that the price difference can never be explained by the products` cost differences. It is a common knowledge that the airline industry has ever practiced price discrimination for several years. We all realize that on every flight the passengers do pay different prices, and also that in certain cases we observe that the maximum price is at times five times the lowest price. How do airline businesses practice price discrimination? Still remains unknown to many. The airline market can easily allow price discrimination to prevail. Barriers to entry emerging from scale economies, sunk costs as well as hub-and-spoke systems offer carriers the necessary market power even on fairly competitive routes. Airlines distinguish among themselves through occupying various slots in flight schedules, and also by offering various route networks. For instance, a carrier with a broad number of connections to the West Coast distinguishes itself from another carrier flying only along the East Coast, despite both of them selling tickets for Boston-Miami route. A market of that kind is therefore monopolistically competitive. Moreover, airline passages differ since they have unstable price elasticities of demand. Even though it`s possible to do a resale of airline tickets, it entails high search costs and also it does not get rid of restrictions, for example blackout days or even time-of-day constraints. So as to price discriminate, airline firms require being able to take apart consumer groups having different demand elasticities. The airline firm can do it by attaching different restrictions to cheaper tickets, therefore making them less attractive to airline passages with high valuation of time or even convenience as well as low price elasticity. As a loophole to exercising price discrimination, the time of buying air ticket functions best. There is no fast and hard rule, but if one buys an air ticket many months in advance it appear to be cheaper. For example, for business travelers, the Virgin Blue demands a full charge of $249 one way. For the next- day travel during the peak, it`s possible to get a restricted discount of about $149 and its present advertised best fare is about $59. This forces the question of how far out does one need to book it? And the answer is at least two months. However, if price matters, then Jetstar is definitely the leading choice available to consumer as one can travel to Sydney from Avalon next-day flight for just $79 one-way though on restricted discount. A month earlier, one can find a $69 fare, however, you need to book at least six weeks up to two months earlier so as to get $59 special offer. If the demand for a particular flight is far above normal, then the airline firms starts raising the price of that particular flight. It implies that the left over tickets can only be bought by consumers willing to part with more cash as the price-inelastic demand. However, if a particular flight is never selling extremely well, then airline will consider doing the opposite and decrease price. With this lower price. It will attract more consumers who are sensitive to slight change in prices. This will definitely ensures that the flight fill up. Ideally, the airline firms would prefer to fill up their plane with passengers who are paying the most they are able and willing to pay. There is no need of selling extremely cheap tickets and having their flight sold out several weeks in advance. Another loophole airline firms exploit is the fact that unsocial hours are cheaper since certain flight times are unpopular, and these flights will definitely tend to be cheaper. For instance, if one take a weekend break. Most consumers would prefer coming back late on Sunday since these late Sunday flights normally tend to be highly expensive compared to early morning Sunday flights. A casual observation would undoubtedly be that there are several different versions of airline tickets to choose from. One can buy an expensive or flexible ticket but then you are permitted to reschedule the flight as well as even canceling it without any costs. Moreover, one can buy an extremely cheap ticket, but with several restrictions. For instance, a Saturday night stay-over is needed and so is the advance-purchase. The fact that each and every traveler can choose between various versions of an airline ticket, it is natural and important to consider the existing theory of versioning especially when analyzing price discrimination in the airline industry Another common feature in most national markets is that huge firms which demands airline tickets do enter into a contract with the airline, where the employees of the firm receives some sort of discount on every airline ticket. This sort of price discrimination, in which different groups are billed different prices, is definitely also a type of discriminating price that need to be analyzed and discussed as far as the effect on the industry in question. We now know very well that airlines use various mechanisms to perform price discrimination between travelers with various willingness to pay for their travel. The ever existing empirical and theoretical literature has investigated many of these mechanisms such as advance purchase restrictions, minimum stay requirements, non-refundability as well as the Saturday night stay requirements. Advance purchase restrictions is normally used to segment travelers by their own value of time and may also be sold disproportionately to travelers with low valuation (Taylor 13-14). Airline tickets having Saturday night stay restrictions as well as other travel and refundability restrictions normally have lower fares, implying that ticket restrictions are usually used to price discriminate. However, previous research has studied whether the airlines segment travelers by day-of-week of purchase. If one is not a business traveler, it can be of a shock to realize the fare you must part with if you have to fly to Sydney from Melbourne at a short notice. At Qantas, for example, in the weekday peak, more frequently than not the lowest fare available is the charge of $368 one-way. If one is to travel up in morning hours, the only way to get a lower fare is normally the first flight at 6am of the day. Trying to fly in the peak will present you a usual full fare or nothing or else if you want less fare, again you need to wait until late evening to strike the cheapest fare deal. In principle, this could undoubtedly be a valuable segmenting tool. Travelers who happen to purchase on the weekend, but travel in some day of the week, may face various price elasticities compared to those who happen to purchase during the week. Furthermore, it would be highly feasible to implement the “day-of-week-of-purchase” plan of pricing since airlines poses the ability to dynamically alter prices daily via sophisticated computer reservation systems. Present revenue management systems utilized by many airlines enables the revenue management analysts to perform a reassessment of pricing daily during the booking process (Taylor & Akila 31-36). This paper make a straightforward and simple contribution to this fact by revealing how airlines charge lower airline fares for observably alike tickets on the day-of-week of purchase basis. This phenomenon of is in line with price discrimination. This idea of price discrimination is essential in its own right since airlines are increasingly making use of complex pricing schemes together with their revenue management systems becoming progressively sophisticated. Rationale of price discrimination as it appears to the airlines, is the justifying factor of their act. Price discrimination is normally thought of as a means to an end as it extract as much more consumer surplus as it`s possible from every group of consumer travelers, given their utility functions: demand elasticities, income and cross-elasticities (Rittenberg 17-20). Price discrimination allows airlines to cash more profit and revenue by exploiting the differing purchasing power of consumers as well as their willingness to pay. It is therefore linked with increasing prices for the less elastic consumers. However, in the case of airlines, they price discriminate through fare discounts which appear to fool consumers and spark their willingness to pay. Therefore, changes in price discrimination entails changes in discounts offered to very price elastic consumers. In such a case, if there is higher competition, it lowers the fares charged to price-elastic airline consumers. It may also entails an increase in price discrimination, that is, the discount connected to any given air ticket restriction may be greater. The importance of price discrimination to airline firm is anchored on their feeling that they will be better off if they practice the third degree price discrimination. This enables the airline firm operating in a monopoly market, to exploit the set of consumers facing a price inelastic demand through billing them a high price. Moreover, they hope to sell more air ticket by set a rather lower price to the set of consumers facing a price elastic demand so as to spur their demand. However, for society at large, in my own opinion, price discrimination is not healthy and I cannot recommend it to airline firms as it may reduce welfare. The major reason for this is that the total loss of consumer surplus on the side of the group of consumers with a price inelastic demand might outweigh the total gain in consumer surplus on the side of the group of consumers facing a price elastic demand (Besanko, David, Ronald & Michael 23-27) A price rise for the set of consumers with price inelastic demand causes the dead weight loss to increase. Dead weight loss is the extra cost incurred by the society or consumers as a result of market inefficiency (Froeb, Luke & Brian 54-57), in this case, price discrimination. These consumers are most likely to carry the burden of price increase in the airline as part of price discrimination which is my opinion is never supportive as far as consumer welfare is concerned. However, despite the price reduction for the other set of consumers resulting in a decrease in dead weight loss, the welfare improvement`s sufficiency condition is still not met. This is because the necessary condition for welfare to rise is that the total output should increase, which is not likely to be the case in this situation. For instance, airlines with a linear demand functions, the third degree price discrimination is never welfare improving. I therefore strongly feel that this pricing system is never equitable and efficient as far as society`s welfare is concerned. Work Cited Besanko, David, Ronald R. Braeutigam, and Michael Gibbs. Microeconomics. Hoboken, NJ: John Wiley, 2011. Print. Froeb, Luke M, and Brian T. McCann. Managerial Economics: A Problem Solving Approach. Mason, OH: South-Western Cengage Learning, 2010. Print. Holloway, Stephen. Straight and Level: Practical Airline Economics. Aldershot, England: Ashgate Pub, 2008. Print. Rittenberg, Libby. Principles of Microeconomics. Nyak, New York: Flatworld Knowledge, 2008. Print. Taylor, John B, and Akila Weerapana. Principles of Microeconomics. Mason, OH: South Western Cengage Learning, 2012. Print. Taylor, John B. Economics. Boston, Mass. [u.a.: Houghton Mifflin, 2007. Print. Read More