Intermediate Microeconomics and Its Application 12th Edition by Walter Nicholson,Christopher Snyder

Exercise 4

Evolving Airline Pricing Strategies
Prior to 1978, U.S. airline prices were regulated by the Federal Aviation Administration. The agency also controlled what flights could be offered and constantly debated standards concerning what perks (such as free drinks) could be offered. All of this ended with the Airline Deregulation Act of 1978, which, over time, allowed airlines to follow whatever pricing and marketing strategies they chose. The effects on the nature of air travel have been dramatic.
Discount Pricing
Probably the most obvious effect of airline deregulation was the move toward discount pricing by most carriers. The goal of such airline pricing schemes was to keep prices relatively high for travelers for whom price did not matter very much (business travelers) but gain revenue from those travelers (such as families on vacation) with relatively elastic demands. To accomplish this goal, airlines adopted a wide variety of restrictions on their discount fares, so that they would be unattractive to business travelers. Overall, the advent of discount pricing resulted in a decrease in the average price of airline tickets of about one-third.
Notice how this explanation for discount pricing is consistent with our discussion of marginal revenue, especially with Equation 8.9. If we assume that the marginal costs of flying business travelers and vacation travelers are the same, the profit-maximizing condition MR = MC implies that prices should be lower for those with elastic demands (check this out for yourself). Once freed from price regulation, airlines were able to adopt more flexible pricing schemes that ultimately enhanced consumer welfare.
Adapting Equipment and Routes
Once they were allowed to choose the routes they could fly, airlines also became more cost-conscious in adapting specific planes to their intended routes. Perhaps the greatest success story was Southwest Airlines, which made the decision only to fly Boeing 737 aircraft over medium length routes. Because the airline did not need to service a variety of aircraft types, and because they could adopt innovative loading practices, they were able to keep plane utilization higher (and costs of flying lower) than their competitors. After 2000, a number of new airlines (such as Jet Blue and AirTran) took the Southwest approach one step further by stressing nonstop flights, especially to vacation locales. The cost-savings from avoiding complex interconnections were dramatic.
Unbundling
Although air travel seems a simple matter of moving people from point A to point B, in fact there are a number of different aspects of this travel that people care about. They want comfortable seats, speed in getting through security lines, and access to overhead luggage space. Prior to 2010, most airlines gave customers no choice on these matters-seating, access, and luggage space were primarily bundled together on a first-come, first-served basis. Eventually, the airlines discovered that their customers were willing to pay separately for these items. So, they began offering special options for buying better seats or for gaining early access to a plane (and thereby securing overhead luggage space). In this case, the logic of Equation 8.9 suggests that those customers with the least elastic demand for such flight amenities would pay the most for them. In some cases, the airlines were able to raise the effective price paid by such customers by as much as 25-30 percent.
Some people view the increasing use of unbundling strategies by airlines to be "unfair." For example, they argue that charging $30 for a better seat ultimately means that higher income people will get better seats than low income people, thereby destroying the "democratic nature" of air travel. Do you agree? Or are better airline seats just like any other good in which the allocation should be determined by willingness and ability to pay?