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The estimated price elasticity of demand for coach class airline tickets for business travelers is estimated to be -1
The estimated price elasticity of demand for coach class airline tickets for business travelers is estimated to be -1.15, while for vacation travelers it is -1.52. Suppose an airline facing these demand elasticities wants to use third-degree price discrimination to maximize profit, by setting the price of a business travel ticket to PB and the price of a vacation travel ticket to PV. You may assume that the airline faces the same marginal cost for both types of travelers. What will be the relative price of a business travel ticket to a vacation travel ticket (PB/PV)?
Expert Solution
Using the Lerner's index, the price is as follows:
(P - MC / P) = -1/elasticity
For business travellers:
(Pb - MC / Pb) = 1/1.15
=> 1.15 Pb - 1.15 MC = Pb
=> Pb = 1.15MC / 0.15
For vacation travellers:
(Pv - MC / Pv) = 1/1.52
=> 1.52 Pv - 1.52 MC = Pv
=> Pv = 1.52MC / 0.52
Thus, Pb/Pv = (1.15MC / 0.15)/(1.52MC / 0.52)
= (1.15*0.52)/(0.15*1.52)
= 2.62
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