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2008-09 Seminars

Testing Theories of Scarcity Pricing and Price Dispersion in the Airline Industry

Steve Puller
Associate Professor Department of Economics
Texas A&M University

This paper uses a unique new dataset - ticket transaction data - to test between two broad classes of theories regarding airline pricing.
The first group of theories postulates that airlines practice scarcity based pricing. This theory suggests that in an industry with high capacity costs and perishable goods, firms facing demand uncertainty set prices in a manner that reflects both the probability of selling and the cost of capacity.
These theories predict that variation in ticket prices and ticket restrictions is driven by differences between high demand and low demand states. In particular, the theories predict that more discounted "advance purchase" seats are sold in off-peak demand periods and that higher shares of low price tickets are sold for off-peak versus peak flights. The second group of theories, as advanced in the yield management literature, indicate that fare variation is driven by differences in ticket characteristics which can be used as fencing devices to price discriminate. We use a census of ticket transactions from one of the major computer reservation systems to study relationships between fares, ticket characteristics, and flight load factors. We find only modest support for the scarcity pricing theories - the fraction of discounted advance purchase seats is only slightly higher on off-peak flights and fare dispersion is nearly the same. However, ticket characteristics that are associated with second-degree price discrimination drive much of the variation in ticket pricing.