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Friday, October 13, 2006

Microeconomics quiz of the week I

From ProfessorJournal.com:
"The number of people involuntarily bumped off flights bounced up more than 40% to 185,368 in the second quarter, compared with the same period in 2005, according to government data.... Also, the number of passengers enticed to voluntarily give up seats on overbooked flights rose more than 10% in the second quarter over last year." The reason for the increase in overbooked flights: Higher fuel prices. With the increased marginal cost of flying planes, airlines have cut back on the number of flights, thus jamming more people onto remaining trips. Furthermore, airlines have the financial incentive to overbook flights. "The DOT requires that airlines compensate passengers for bumping them off flights, but the maximum amount of $400 was set in 1978 and hasn't changed. Had the maximum amount been adjusted for inflation, it would be more than $1,200 today. And some argue that since the last tickets sold are usually more expensive, airlines have too much incentive to sell $1,000 tickets when no seats are available if the penalty is only $400 to bump a cheaper-fare passenger." The article also discusses the fairness of the practice, and presents consumer advocate Ralph Nader's suit of Allegheny Airlines for the practice of overbooking.

QUESTIONS:
1.) Why does the policy of airlines paying bumped flyers $400 encourage airlines to overbook flights?

2.) Does overbooking result in lower airline prices?

3.) The article states, "'An airline seat is perishable,' says David Castelveter, spokesman for the Air Transport Association industry trade group." In this case, what does perishable mean? Why do perishable seats encourage airlines to overbook?

4.) "If you are on an oversold flight, don't have a confirmed seat and must get on the plane, Mr. Anolik suggests offering compensation on your own to people who do have seats. He gave a traveler $200 once, saving himself four hours of delay waiting for the next flight. Since he bills $395 an hour, he figured it was a bargain." Discuss how the opportunity cost of Mr. Anolik's time affects his offer and the willingness of someone to accept his offer.

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