Business Ethics

fare information. Initially these were internal systems, but were soon made available to travel agents.

Deregulation of airline pricing in 1978 permitted much more extensive use of the systems for economic

activity, especially pricing. The initial development of dynamically adjusted pricing is often credited to

American Airlines' Robert Crandall, as a response to the rise of discount airline People's Express in the

early 1980s. The complexity and opaqueness of airline pricing has grown over time. As a result, the

"yield management" systems employed by airlines for pricing have become one of the most arcane and

complex information systems on the planet, and one with a very large economic component. Airline

pricing represents a great challenge for modern economic analysis because it is so distant from the "law

of one price" level of analysis. This paper surveys the theoretical literature, which is mostly found in

operations research journals, develops some new theory, assesses the holes in our knowledge, and

describes some results from a new database of airline prices.

Dynamic pricing, which is also known as yield management or revenue management, is a set of pricing

strategies aimed at increasing profits. The techniques are most useful when two product characteristics

co-exist. First, the product expires at a point in time, like hotel rooms, airline flights, generated

electricity, or time-dated ("sell before") products. Second, capacity is fixed well in advance and can be

augmented only at a relatively high marginal cost. These characteristics create the potential for very large

swings in the opportunity cost of sale, because the opportunity cost of sale is a potential foregone

subsequent sale. The value of a unit in a shortage situation is the highest value of an unserved customer.

Forecasting this value given current sales and available capacity represents dynamic pricing.

Yield management techniques are reportedly quite valuable. One estimate suggests that American

Airlines made an extra $500 million per year based on its yield management techniques (Davis 1994).

This number may be inflated for several reasons. First, it includes sales of yield management strategy to

others, as opposed to American's own use of the techniques, although the value of American's internal

use is put at just slightly less. Second, it incorporates "damaged good" considerations in the form of

Saturday-night stayover restrictions, as well dynamic pricing. Such restrictions facilitate static price

discrimination, and are reasonably