Question

Airlines routinely overbook flights, selling more tickets than seats available. If too
many ticketed passengers show up, they offer payments to volunteers who are
willing to give up their seats. These take such forms as cash vouchers for future
flights and upgrades to first class on the next flight out.
a. Why is this situation more efficient than a simple rule that prohibits airlines
from overbooking? (Be sure to say precisely what you mean by efficiency.)
b. Why do you (probably) not object to the airline practice of bribing passengers
off the plane, but you (probably) would object if you learned that the airline had
bribed a local politician to obtain airport gate space that would otherwise have
been used by a competitor?

Please justify with relevant economic concepts.

Answer 1

Introduction

Airlines industry is one of the most complicated ones if you do not understand the economics behind their management. Over the years, service industries have deployed various methods such as over booking to avoid losses during peak seasons.

In peak season, even though the demand for airlines is very high, the rate of cancellation increases and people are refunded back their money. The Airline on its part loses out on making profits from the seat and as a result sees wide scale problems for itself.

Therefore, the concept of over booking a flight in which the total number of passengers may be 100 but, tickets were given to 105 is allowed. This is because airlines expect some degree of cancellations and accordingly adjust the total tickets available and is completely legal to do in most countries across the globe.

Case Specifics: -

A) The reason why over booking a flight is efficient for a company is that money for flight tickets is collected in advance. Meaning that the company creates capital right from the day the tickets are booked. This capital can be used for a lot of things. Even though a single ticket may not seem a big amount, however for any airlines this creates a huge pool of capital availability which reduces costs and increases profit margins.

Further, for the airline cancellations come at a cost. This includes cost of refunds as well as costs of lost business from eateries and other goods which are sold by the airlines to the end consumers.

Thus, the efficiency of overbooking and still compensating people arises from the fact that the probability of cancellations has already been considered before using this option. A company would not over book if demand was low. Further, even if it does have to pay customers, that comes at operational costs only as people are adjusted in flights, the cost of which may not be at par with what the customer has paid for the airline.

B)

The reason why we do not object to the same is because cancellations are indeed causing issues for the airlines industry which runs on minimum profit levels. We are not bribing the customers but are giving them a future experience for their loss of time.

On the contrary, giving out money to a politician is directly engaging in generation of black money which harms the economy and creates more problems than it ever solves.

Please feel free to ask your doubts in the comments section.