Question

Consider a monopolist airline with 100 potential customers, 10 of which are business travellers and 90 of which are tourists. A business traveller is willing to pay 1000 for a first class seat, and 500 for an economy class seat. A tourist is willing to pay 400 for a first class seat and 300 for an economy class seat. The marginal cost of an economy class seat is 200, the marginal cost of a first class seat is 400.

(a) Suppose you can observe the type of a customer. Which prices would you charge a business traveler for each seat? Which prices would you charge to a tourist? What are the resulting profits?

(b) Suppose now you cannot observe the type. What is the price you should charge for an economy class seat? What price should you charge for a first class seat? Which customers are choosing which seat and what are the resulting profits?

(c) Suppose that business travelers have to change their travel schedule frequently and will only buy a ticket if they have an option to change their flight. What strategy could you use to increase profits?

(d) Suppose now that there are 90 business travelers and 10 tourists, but you cannot observe the type. What is the price you should charge for an economy class seat? What price should you charge for a first class seat? What are the resulting profits? Is your answer different from part b? Why?

please answer B and D at least (:

Answer 1

Business travelers -10

Tourist- 90

Willingness to pay of business for:

First class seat- 1000

Economy-500

Willingness to pay of tourist for:

First class seat- 400

Economy-300

Marginal cost of economy seat is 200 and that of first class seat is 400.

a) Since we observe the type of customer we know we have 10 business men and 90 tourists.

Thus, since we know that the business man will be willing to pay 1000 for a seat we can charge him the same. Thus earning profit of $600 ($1000-$400) on each seat.

As the tourists are more, we would be charging them the price equal to their willingness to pay and nothing more than that. Thus we charge them $300 and earn profit of $100($300-$200) on each seat. However, if we charge higher price than the willingness to pay, we earn super normal profits.

b) Since we don't know the type of customers, the price that we should charge for an economy class seat shall not be anything more than their willingness to pay i.e. $300. This way it attracts both the tourists and the business man also as both their willingness to pay is well within the price charged.

However, the price that we shall charge from the first class seat shall be anything greater than $400. This is because, we don't know if the person is a business man or tourist. We cannot charge a price of $400 as the tourist will choose first class and the profit per seat in that case will be 0. For a business he may now choose an economy seat (if price is less than $500) or a first class seat depending on his preference. The profit in this case will be higher ranging from $ 1($401-$400) to $ 600($1000 - $400) .

c) To increase our profits in such a situation, the airline must charge them equal to their willingness to pay for a first class seat i.e. $1000 if the seat is available in that plane.

And in case only economy seats are available, they shall be charged $500.

d) When the business men are more than the tourists, it is more profitable to charge price equal to businessmen willingness to pay.

Thus, the price charged for economy class shall be $400. This way, the business man who wants an economy seat will buy it at less than his willingness to pay and a tourist who is not willing to pay $400 will not buy the seat. Profit if businessman buys it is $200 per seat.

The price charged for a first class seat shall be $1000 as the businessman will be willing to pay that for the seat. The profit in this case is $600. However, there would be low probability of a tourist buying any seat.

There are different results than that from part b and it is because of the different proportion of customers present.