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

Abstract

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, as advanced by Dana (1999b) and Gale and Holmes (1993), postulates that airlines practice scarcity based pricing and predict that variation in ticket prices is driven by differences between high demand and low demand states. Dana's theory predicts that airlines sell tickets with higher and more dispersed prices in unexpectedly high demand states; Gale and Holmes predict that more discounted seats are sold in off-peak demand periods. Both of these groups of theories predict substantially higher shares of low price tickets in 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 as associated with price discrimination. 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. The central advantage of our dataset is that it contains additional variables not previously available. These variables measure both the ticket characteristics central to the price discrimination theory and information on load factor and peak/off-peak travel times needed to test the scarcity pricing theory. 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.