Price Discrimination in Airline Industry

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It is commonly known that the airline industry uses a different mechanisms to price discriminate (PD) consumers with varying elasticities of demand in terms of travel.^[1] In this case study, I will investigate PD based on the day of the week a ticket is purchased. In theory, this method of price discrimination is very feasible as airfares can be easily changed on a day to day basis. For example, consumers who travel on any given day of the week but purchase on the weekend may have different PED than those consumers who purchase their tickets during the week. By comparing different days of the week and ticket prices, we can study whether the airline industry has identified this method as a valuable segmenting device. I will start this case study by defining the theory of PD then continue by assessing data regarding ticket prices and day of week of which purchased then conclude if there is enough evidence of PD.

Price discrimination is the practice of charging consumers different prices for the same good or service, whereby the relevant price in each case depends on the buyers characteristics. The most common form of PD would include grouping consumers based on certain attributes and charging these groups a different price. In pure price discrimination, the price of a good or service will be set at the maximum of which each consumer is willing to pay.

The goal of PD is to gain an extra slice of untapped revenue source from consumers who are willing to pay a higher price and those consumers who are only willing to pay lower.^[2] PD allows a firm to gain higher profits than standard pricing as some consumer surplus is changed to producer surplus.

The conditions for price discrimination^[3] include the ability for a firm to set prices; must have market power (this is the case for all non perfectly competitive markets), markets must be separate; consumers should be refrained from reselling their good or service, and finally the firm must be able to detect and group the different elasticities between the markets.

The three types of PD would include first, second and third degree, where the first-degree PD corresponds to perfect price discrimination; firm charges each consumer the maximum price they are willing to pay. Second-degree PD is when a firm charges consumers different prices according to the quantity they are looking to purchase. The third-degree PD takes place when different prices are set in different market segments; meaning consumers are grouped into two or more markets of which prices vary from one group to another.^[4]

The focus of this essay is on the U.S airline industry. To overcome the limitations of this case study, I will be comparing data with the day of purchase as the only variable^[5]. We will also be concentrating on transacted fares instead of online fares.^[6]

The strategy undertaken in the case study is to test if there is a difference in mean prices between fares transacted during the weekday and the weekend. As mentioned above, it is essential to control the variables in the data to ensure that the difference in fare prices can be attributed only to supply side behavior of the firm.