According to an article entitled "Concepts of Price elasticities of Transport Demand and Recent Empirical Estimates," Journal of Transport Economics, the estimates of the price elasticity of demand for selected modes of transportation is as follows:
Category: Estimated Elasticity:
Airline travel, Leisure -1.52
Airline travel, Business -1.15
Suppose an airline company wants to use third-degree price discrimination to maximize its profits, by setting the price of a business travel ticket to P(b), and the price of a vacation (leisure) travel ticket to P(v). Also suppose the airline faces the same marginal cost of $30 for both types of travelers.
1. Explain third-degree price discrimination?
2. What should be the ratio of P(b) and P(v), that is P(b)/P(v)? Show Work.
3. Which type of customers should the airline company charge a higher price, and why?