An airline regularly running a flight between Chicago and Zurich has 100 business travelers who are...

An airline regularly running a flight between Chicago and Zurich has 100 business travelers who are willing to pay $1000 for a ticket and 50 tourist travelers who are willing to pay only $500 for a ticket. There is a $20,000 fixed associated with running the flight, which is fixed regardless of the number of passengers on the plane. a.Suppose the airline must set a single ticket price. What is the optimal ticket price? How much revenue does the airline earn and how much profit does it make?b.Now suppose that the airline can price discriminate by charging different prices to business travelers and to tourists. What are the airline’s revenue and profit now?c.The airline attempts to price discriminate in the following way. It initially sets the ticket price at $1000, so that business travelers will buy tickets immediately. A few days before the flight, it lowers the price to $500, hoping that tourists will buy a ticket. What problem would the airline would run into if it applied this strategy repeatedly?

Expert Solution

There are 100 business travelers with WTP = $1000 for a ticket and 50 tourist travelers with WTP = $500 for a ticket. There is a $20,000 fixed cost

a.If the airline must set a single ticket price. the optimal ticket price is the profit maximizing one. When it charges $500, then the airline is able to sell 50 + 100 = 150 tickets and earn a profit of 150*500 - 20000 = 55000. If it charges a price of $1000, it will be selling 100 tickets and earn a profit of 100*1000 - 20000 = 80000. Profits is higher when the price is $1000. Hence the optimal price is $1000 per ticket.

Its revenues are 100*1000 = 100000 and profits are 80000.

b.Now suppose that the airline can price discriminate by charging different prices to business travelers and to tourists. It then charges the WTP from each consumer type/ Its revenue are 100*1000 + 50*500 = 125,000. The profits are 125000 - 20000 = 105000.

c.The airline initially sets the ticket price at $1000, so that business travelers will buy tickets immediately. A few days before the flight, it lowers the price to $500, hoping that tourists will buy a ticket. If it applied this strategy repeatedly, business travellers are able to realize that prices will fall down later so they will also book late. Ultimately the airline will be selling all tickets at 500 earning the lowest profit.

Rahul Sunny answered 2 years ago

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