Answer to Question #198534 in Microeconomics for Mindy

Question

Qantas identified that its business traveller customers have a less elastic demand curve for airline travel than non-business customers, as well as shorter intervals between forward and return trips.

 

a)    Explain how this market situation provides an opportunity for third-degree price discrimination to increase Qantas profits over a common ticket price for all travellers.

 

b)   Suppose that at the current ticket price, the price elasticity of demand for their customers is 0.8. What does this imply for Qantas profits and a more sensible price strategy?

c)    Assume that the MC per return ticket is constant. Furthermore, suppose Qantas uses the third-degree price discrimination strategy you proposed in (a) and finds that the demand elasticity for return flight tickets with shorter intervals is 2.0, while that for flights with longer intervals is 4.0. Explain with maths how prices in the two markets relate to one another. 

Answer 1

Solution:

a.). Elasticity refers to the extent of responsiveness in supply or demand in relation to changes in price. If a curve is more elastic, then small changes in price will cause large changes in quantity demanded. If a curve is less elastic, then it will take large changes in price to effect a change in quantity demanded.

Third-degree price discrimination happens when a company charges a different price to different consumer groups. In this case, Qantas can increase the ticket prices for business traveler customers while maintaining the same prices for other non-business customers. This is because the demand for air tickets for business traveler customers is less elastic, meaning that a slight increase in their ticket prices will not have a significant effect on their demand. By doing so, Qantas will still maintain the same demand but increase its revenues and profits due to the increase in ticket prices for business traveler customers.

 

b.).  The price elasticity of demand is a measure that captures the responsiveness of a good’s quantity demanded to a change in its price.

The current ticket prices for Qantas have a PED of 0.8, which means that the tickets are inelastic. That is a change in price causes a smaller percentage change in quantity demanded and consumers are insensitive to changes in price. Therefore, this implies that Qantas will use a price discrimination strategy by increasing the prices of the tickets since the quantity demanded will not be affected. This will increase their revenues and profits due to the ticket price increase.

c.). The market for return flight tickets with shorter intervals has a less elastic demand compared to the market for return flight tickets with longer intervals.

Under a two-part tariff with identical consumers, price and output are determined where P = MC. Therefore, to maximize profits, where MC = MR, each market will have its own demand and MR curve and Qantas will have to ensure the marginal benefits to business traveler consumers are identical on both routes.

P = MC

MC = MR