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Risk: Seat Pricing on an Airline

Prior to 1978, civil aviation in the United States was regulated by the Civil Aeronautics Board (CAB), and route and fare changes took quite a bit of time. The 1978 Airline Deregulation Act gave airlines the freedom to enter or exit routes and alter fares at will. One immediate result of deregulation was the proliferation of "discount" fares (which usually come with some restrictions). For this simplified case, assume that the airline has, for one of its regular routes, a full-fare ($500) and a discount fare ($100). An aircraft seat on this route is a "highly perishable commodity" in that once the plane takes off, any unsold seats are lost forever. The challenge of "yield management decision making" is to balance the trade-off between selling too many discount seats (and having to turn away late full-fare passengers) and selling too few discount seats (and having empty seats on the flight). In this case, the plane has 100 seats and the demand for discount seats is unlimited (they will sell all they put up for sale). The demand for full-fare seats is equally likely to be any number between 26 and 30 (inclusive). How many seats should be protected for full-fare sales?

[Note: if the airline protects 28 seats, for example, and only 26 full-fare sales take place, that means that 2 seats (28 - 26) fly empty, yielding no revenue.]

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The answer to this question really depends on the risk nature of the airline management. If airlines is risk averse then ...

Solution Summary

The solution evaluates the risk tolerance of the company to answer the question in the scenario below in 89 words.