Question

York Airlines offers three classes of service on their flights between Toronto and Vancouver: 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?

(c) Suppose that business class tickets go on sale, and their price falls to $790. What kind of ticket will Andrew purchase? What kind will Rebecca purchase? What are York Airline’s total revenues?

(d) Suppose that the airline decides to reduce the cost of business class tickets even further, cutting the price down to $590. What kind of ticket will Andrew purchase? What kind will Rebecca purchase? Is this a good pricing strategy for the airline?

(e) Now suppose that York Airlines decides to get rid of the premium economy seats on their fleet. They maintain their $300 economy class tickets, but increase the price of business class tickets back up to $790. Is this a good strategy for the airline?

Answer 1