Question

You are the manager of an airline that flies from Accra to Kumasi every week with a constant marginal cost . The airline is a local monopoly that carries business and vacation travelers to all major cities in Ghana. If business travelers (those who travel on weekdays) have an elasticity of demand of flight of -2 and the vacation travelers ( those who travel on weekends) is -5, what should your pricing policy be to maximize profit?

Answer 1

Business travelers have an elasticity of demand of -2.

While vacation travelers have an elasticity of demand of -5. Thus vacation travelers are more inelastic than business travelers, it essentially means that when the price changes, the demand doesn't change as drastically and stays the same.

So when the price increases, vacation travelers continue to travel and are willing to pay more, while business travelers are reluctant to pay more, which is why their elasticity is higher than that of the vacation travelers.

Thus in order to maximise profits the prices will be higher over the weekends as vacation travelers travel over the weekends and the firm will earn more as the price increase doesn't lead to reduction in demand. For example if the price increases from $100 to $150, the firm earns higher revenue.

While the company will increase the prices only marginally during weekdays otherwise business travellers won't travel as much. For example the firm will have to increase the prices from $100 to $120 in order to seek higher profit due to comparatively elastic demand. If price increases a lot then demand might fall as business travelers are more elastic than vacation travellers.