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CHAPTER 3 - DEMAND ANALYSIS AND OPTIMAL PRICING See opening quote (p. 79): There's no brand loyalty that the offer of a "penny off" can't overcome it. OPENING CASE: AIRLINE TICKET PRICING, PRICE DISCRIMINATION On a typical United Airlines flight from Chicago-LA, there were at least 27 different fares charged, from $87 to $1248 depending on which factors? This pricing strategy is called "price discrimination," where firms charge different prices to different customers for the same product or service , depending on different customers' price sensitivity or price elasticity of demand . Who pays a higher price, customers with elastic demand (price sensitive) or inelastic demand (price insensitive)? Airlines use a pricing strategy called "yield management," based on demand analysis, to determine how many prices to charge, how often to change prices, etc., with the goal of Maximizing Profit. They would like to fly planes as full as possible, as often as possible, and charge the maximum price possible to maximize profits. "Charge whatever the market with bear." Other examples of Price Discrimination: a. b. c. d. e. DETERMINANTS OF DEMAND In the simplified model in chapter 2, we assumed that demand was a function of only one variable: ________ [Q d = f (P)]. We now allow for other factors to affect Demand, such as? Case Study: An airline flies two flights daily between Houston and Orlando and faces a single competitor on this route. The airline determines that demand for coach-class tickets primarily depends on three variables: Its own price for tickets (P), its competitor's price for tickets (P c ), and the income level (Y) of the customers flying between Houston-Orlando. The general demand function or equation for the number of tickets sold per flight would be: Q d = f (P, P c , Y) What are the expected signs of these 3 variables (positive or negative)?? ECN 469: Managerial Economics Professor Mark J. Perry 1
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Suppose that the forecasting department has estimated the following specific demand equation for ticket sales (Q d ) based on past history of ticket sales: Q d = 25 + 3Y + 1P c - 2P Assume that Income (Y) is measured by an Income Index, based on Personal Income and Business Profits in Texas and Florida, Index = 100 in the base year 1994. The interpretation of the coefficients in the estimated demand equation is: 1. For every 1 point increase in the Income Index (Y), there will be 3 additional tickets sold per flight, ceteris paribus. 2. For every $1 increase in competitor's price, there will be 1 additional ticket sold, ceteris paribus. 3. For every $2 increase in its own price, the airline will sell 2 fewer tickets, ceteris paribus. For example, assume that Y = 105, P c = $240 and P = $240. Q = 25 + 3 (105) + 240 - 2 (240) = 100 tickets.
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