price discrimination in the airline industry - Fagbokforlaget

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discrimination in such a way opens new markets, it is plausible that it leads to increasedoutput and therefore improves welfare.What if we have competition rather than monopoly? This may overturn our resultsreported so far. It all depends on how competition evolves. There are reasons to believethat price competition will be more intense in some market segments than others. Forexample, private and public firms that are large consumers can exploit buying power bytriggering competition between the producers for an exclusive contract. In other segmentsthere might be no such buying power present. If so, by allowing for third degree pricediscrimination one may trigger intense price rivalry in some market segments. Asubstantial price reduction in some segments suggests that the output in those segmentincreases by a substantial amount. On the other hand, as shown above it may also implythat prices increase in other market segments.Figure 6 Welfare effects of third degree price discrimination with competitionPricePriceWelfare gainWelfare lossP 0P CPRICE INELASTIC CONSUMERS PRICE ELASTIC CONSUMERSP 2P 1Marg. costQuantityQuantity© Steen and Sørgard 14
Even if third degree price discrimination triggers intense price rivalry in some segments,it might be detrimental to welfare. In Figure 6 we have replicated Figure 5. Now the pricewe will have without price discrimination is lower than in the case with a monopoly firm,labeled P C in Figure 6. Let us assume that third degree price discrimination triggersintense rivalry on prices in the price inelastic market segment. In the Figure we assumethat price equals marginal costs in that segment. The price setting in the other segment isthen no longer constrained by the competition for the price inelastic consumers. Then thefirms may respond by increasing the price in the price elastic segment. As we see, even alimited price increase in the other market segment will lead to a welfare loss thatoutweighs the welfare gain in the segment with intense price rivalry.The example shown in Figure 6 illustrates a case where third degree pricediscrimination leads to large price reductions in one segment and only a limited priceincrease in another segment. But even then it can be detrimental to welfare. It illustratesthat the crucial point is to investigate the characteristics of the segments and how thirddegree price discrimination affects different segments. In particular, is demand priceelastic in the segment where third degree price discrimination triggers tough pricecompetition? If not, a large price reduction has only a limited effect on output in thatsegment. In such a case a limited price increase in the price elastic segment may lead toan output reduction that is large enough to outweigh the output increase in the othersegment.So far we have assumed competition both before and after the introduction ofthird degree price discrimination. Note, however, that third degree price discriminationcan ruin profits when firms compete. As illustrated in Figure 6, third degree pricediscrimination can trigger intense price rivalry in some market segments. If so,competition may no longer be viable. Then the alternatives to compare are competitionwithout price discrimination and monopoly. It should be obvious that welfare is higherwith competition than with monopoly, which implies that society as a whole is better offwith no third degree price discrimination in a competitive environment.© Steen and Sørgard 15
Page 1 and 2: PRICE DISCRIMINATIONINTHE AIRLINE I
Page 3 and 4: various kinds of price discriminati
Page 5 and 6: If the quality of the good equals Q
Page 7 and 8: As shown in Figure 3, the quality o
Page 9 and 10: consumers’ consumer surplus. Rear
Page 11 and 12: products. This would lead to an inc
Page 13: A price increase for the group with
Page 17 and 18: The solid line is the demand if the
Page 19 and 20: 3. THE AIRLINE INDUSTRYIn the previ
Page 21 and 22: flexible air ticket, labeled C-clas
Page 23 and 24: city pair market and the importance
Page 25 and 26: very intense rivalry on prices. The
Page 27 and 28: When airlines compete, there might
Page 29 and 30: Holmes, T. J. (1989): ‘The Effect

price discrimination in the airline industry - Fagbokforlaget

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