Price Dispersion and Consumer Upgrade: Theory and Empirical Evidence from Airline Industry

44 Pages Posted: 10 Feb 2017  

Yao Cui

Cornell University - Samuel Curtis Johnson Graduate School of Management

A. Yesim Orhun

University of Michigan, Stephen M. Ross School of Business

Izak Duenyas

University of Michigan, Stephen M. Ross School of Business

Date Written: February 7, 2017

Abstract

In recent years, major U.S. airlines introduced the option to upgrade to premium economy seating which provides comfort-enhancing features compared to regular economy seating. This paper examines the effect of the introduction of this upgrade option on the airline’s price dispersion in the main cabin. We first provide a theoretical analysis of the airline’s optimal pricing policy when customers exhibit multi-dimensional heterogeneity, and the airline price-discriminates intertemporally for its regular economy seating and can offer an upgrade option to premium economy seating. Our analysis highlights two competing pressures on main cabin prices. On the one hand, the airline benefits from lowering its prices because by allowing more customers to purchase in the first place, it increases the probability of selling upgrades (admission effect). On the other hand, for some customers, the value of flying with the airline increases due to the upgrade availability, therefore the airline may find it optimal to increase its prices (valuation effect). In the second part of the paper, we conduct an empirical investigation of the impact of the introduction of the upgrade option on main cabin prices based on a proprietary transaction-level dataset from a major U.S. airline company. The empirical analysis tests the main predictions of our theoretical model and provides further insights. The results show that the introduction of the premium seating upgrade is associated with an increase in the price dispersion in the main cabin, the admission effect is stronger than the valuation effect on the low-end of the price distribution, and the opposite is true on the high-end of the price distribution.

Keywords: Price Dispersion, Price Discrimination, Upgrade, Airline Industry

Suggested Citation

Cui, Yao and Orhun, A. Yesim and Duenyas, Izak, Price Dispersion and Consumer Upgrade: Theory and Empirical Evidence from Airline Industry (February 7, 2017). Available at SSRN: https://ssrn.com/abstract=2914625 or http://dx.doi.org/10.2139/ssrn.2914625

Yao Cui (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

A. Yesim Orhun

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

Izak Duenyas

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

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