A monopolistic airline operates on two routes: Route X, which is primarily used by busines… — JAMB UTME

A monopolistic airline operates on two routes: Route X, which is primarily used by business travelers with a price elasticity of demand of $0.6$ , and Route Y, which is primarily used by vacationers with a price elasticity of demand of $2.2$ . To maximize total profit through third-degree price discrimination, how should the airline set its fares on these two routes?

Charge a higher fare on Route X and a lower fare on Route Y.Answer
B
Charge a higher fare on Route Y and a lower fare on Route X.
C
Charge identical fares on both routes to ensure marginal revenue equals price in each market.
D
Lower the fare on Route X to shift its demand curve outward to match Route Y.

Answer

Charge a higher fare on Route X and a lower fare on Route Y.

Under third-degree price discrimination, a firm maximizes profit by charging a higher price in sub-markets with lower price elasticity of demand and a lower price in sub-markets with higher price elasticity of demand.

Step-by-Step Solution

Analyze the price elasticity of demand for each route

Route X has inelastic demand (

|e_d| = 0.6 < 1

) and Route Y has elastic demand (

|e_d| = 2.2 > 1

Price elasticity indicates consumer sensitivity to changes in price.

Apply the third-degree price discrimination profit-maximization rule

Equate marginal revenues across markets (

MR_X = MR_Y = MC

), where

MR = P(1 - 1/|e_d|)

Because consumers on Route X are less price-sensitive, a higher price increases total revenue with a relatively small drop in quantity demanded.

Determine the relative pricing strategy

Set a higher price on Route X and a lower price on Route Y.

This allocation captures greater consumer surplus and maximizes overall monopoly profit.

Key Concept

Third-Degree Price Discrimination and Elasticity Rule

Question

Answer

Step-by-Step Solution

Key Concept

Common Mistakes

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