Who hasn’t heard an airline gate attendant announce, “We are in an overbooked situation and are offering $xxx to anyone willing to give up a seat and take a later flight?”
The problem with this announcement for the airlines is that there is often a rush of people supplying seats — the $xxx is above equilibrium, and the airline is offering some volunteers a substantial consumer surplus.
Northwest Airlines has found a way to circumvent this: When you check in online, the website states that the flight is very full and they are accepting volunteers to give up seats. If you click “yes” to indicate your interest, it then ask how much money you want as compensation. It notes clearly that they will take the lowest offered prices first. If it needs 10 volunteers, Northwest could offer each the tenth-lowest price offered, reducing consumer surplus, and saving itself money compared to the gate announcement.
But why not go whole-hog: Give each of the volunteers exactly what she/he offered, thus entirely wiping out consumer surplus. I bet they do that.
This is a rare example of perfect price discrimination, and it wouldn’t have been possible without the internet.
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I wonder how the future price would compare to the spot price here. I might write down that I would give my seat up for $100, but staring the announcement in the face, I might end up having a different reservation price. It seems like there is an insurance role here. If I get to choose in the moment, I am better off than if I have to list a price ahead of time.
This made me question the whole homo economicus assumption. Honestly, I wouldn’t really know how to accurately assess my valuation of the inconvenience of getting a later flight. I feel like without an anchoring value, estimating wtp might be difficult, so the selection of volunteers might become a little random. Not that that’s a problem for Northwestern, unless people are inclined to state figures above the amount that would be offered at the gate.
Who needs the net? When a flight is overbooked, the gate agent could pass out bid forms and golf pencils to the assembled, ask for an offer to be bumped, collect the bids and sort low-to-high.
Collusion is a possible downside, but there’s a big upside since the passengers have more timely valuations of the bump to base their offers on.
The big problem here is that if the plane is so overbooked, then those low-ballers might realize that they undervalued the “true cost” to others of not taking the seat. The cost of one’s lost time (or travel) is not the same as the reservation price once they see a captive audience. Point being, using the example you give, if the lowest bidder realizes that the plane needs to kick off 10 people they just need to match the 10th person–and thus the perfect price discrimination is gone.
Not quite perfect, I can think of several other variables that would change my offer. If I’m travelling with a companion, my price is different if they need only one of our seats versus both seats. This is something they won’t know until boarding time but their asking me to set a price at check-in, up to 24 hours earlier.
Expanding on #1 Brad, why not just have all airplane seats prices as commodities. As the seats get full, the prices would go up and there’d be no overbooking. People who plan far in advance can buy at a reduced price and resell if the price goes up. It’d be a great way to get an equilibrium in all seat prices.
I highly doubt entering in your desired amount constitutes a binding contract. So if I enter $100, and find out they need so many seats that someone else is getting $400, wouldn’t I just back out? Suddenly, a bidding war ensues, right? They need my seat – maybe someone will take $350? In fact, if they need so many seats, the $400 person might try to hold out for $500.
I think this confusion might make it easier on the airline to just offer everyone that $400.
#5: precisely.
Also, if I’m travelling on business or leisure. If I have a meeting to attend, how late can I ‘afford’ to be.
If I’m on vacations, how long can I postpone my arrival?
Etc.