Consider the following problem: A flight from Chicago to New York 2 weeks from today has 170 seats. 65 seats are "protected" as high paying and 150 are economy.
• 50 of the high paying seats have been sold.
• All unfilled economy seats have been auctioned off at a discount and have been sold Five days before departure another economy order arrives at the airlines reservation system. The airlines must make a decision to allocate or not allocate seats from its high paying segment to economy. Here are some profit numbers
• Price of high paying seat is $700 dollars and the marginal profit is $500
• Price of economy seat is $160 dollars and the marginal profit is $100 If the airline where to allocate the vacant seats from high paying to economy, it faces the risk of "stock out", inability to fulfill a high paying customer order because the seat has been allocated to economy, thereby earning lower marginal profit. Based on the above, answer the following questions.
1. Why do airline companies offer free upgrade to business/first class to economy passengers at the moment of departure? What are the costs and benefits of this decision?
2. Discuss the rationale underlying the airline decision to auction discount seats to third party vendors (costs and benefits)?