Third degree price discrimination in airline industry

THIRD DEGREE PRICE DISCRIMINATION IN AIRLINE INDUSTRY

Third-degree price discrimination is one technique of "charging various prices for the same product in different parts of a market" ( Housman, 1988). Varied segments of a market might include time or location whereby the provider delivers items at different rates based on the time of purchase or by a consumer's location.

The standard scenario happens when markets are separated. In this situation, the monopoly implements typical monopoly pricing in each of its markets. That is to argue that if the monopoly has a constant marginal cost, its profit maximization challenge will be:

This suggests that the prices charged in the different marketplaces will be:

Where is the elasticity of demand for market i. From this, it is evident that markets with a higher elasticity of demand will have a lower price than markets with a lower elasticity of demand. If the markets are not separated, then the monopoly confronts the same pricing limitations as in second-degree price discrimination:: (Varian, 1992)



Figure 1 Market A is a business with a higher elasticity of demand, whereas Market B has a lower elasticity of demand. It is desirable for the monopoly to set a higher price in the market with lower elasticity/greater inelasticity (Market B). Considering that both industries are the same size, then the producer surplus (the shaded region) will be greater in Market B.
For any particular aircraft route, two instances of third-degree pricing discrimination are identified. The first of these examples is the direction of a flight (or beginning place of a round-trip journey) (or starting location of a round-trip journey) (He, 2016) Consumers in various geographical regions may differ in their willingness to pay for tickets, and an airline might thus benefit from charging different rates in different markets. In the event of the geographical origin of a journey, the markets might be regarded as distinct. The second sort of third-degree pricing disparity is the time of the trip. If individuals differ in their preferences for the time of departure, airlines may employ this to charge a higher premium in markets with poor elasticity. In this circumstance, the markets are typically not separate.
Reference list:
Varian, H.R., 1985. Price discrimination and social welfare. The American Economic Review, 75(4), pp.870-875.
Chressanthis, G.A. and Chressanthis, J., 1993. Publisher monopoly power and third-degree price discrimination of scholarly journals. Technical Services Quarterly, 11(2), pp.13-36.
Hausman, J.A. and MacKie-Mason, J.K., 1988. Price discrimination and patent policy. The RAND Journal of Economics, pp.253-265.
He, Q., 2016. The effect of competition on price discrimination in the international flight market between the US and China. Economics of Transportation, 7, pp.1-23.

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