Question

Exercise 3. Third Degree Price Discrimination Some air routes are only served by a couple of airlines. Suppose that LAX-SFO is only served by one airline that can exert monopoly power. This airline is aware that it has two types of customers. Business travelers fly out on Monday early morning and fly home on Friday afternoon, and have an inelastic demand (not very flexible schedule). Vacation travelers fly out on Friday afternoon and return early Monday morning, and have an elastic demand (more flexibility). The inverse demand for business travelers is PB(XB)=190-2XB, and the inverse demand for vacation travelers is PV(XV)=110-XV. The variables XB and XV are the numbers of business and vacation travelers in a Monday or Friday flight. The marginal cost per passenger is MC=50 regardless of type of passenger.

a) What are the marginal revenues MRB and MRV? Considering MRB=MC and MRV=MC, how much should the airline charge for flights that include a weekend stay, and how much for flights that do not include a weekend stay? How many customers XB and XV will purchase at these prices? What is the overall profit π = πB + πV?

b) If the airline decided not to discriminate, what is the overall demand it faced? Calculate X=XB+XV after deriving the demand curves from the inverse demands given above. Given MR=MC, how much would the airline charge? How many customers would purchase? What happened to the deadweight loss? Did it get worse or did it improve compared to the price discrimination in part a?

Answer 1