The government of a small island developing country (SIDC) gives an exclusive right to an airline firm as a monopoly. Interestingly, the monopolist puts in place a structure that matches citizens in the country with a fare it thinks the citizens will be happy to pay for the seat. If a citizen is in the frequent flyer or loyalty scheme database, it will know all about the citizen’s flying habits in terms of routes, frequency, scheduling, and the price paid. Through these schemes, the citizen has already volunteered the airline data on his/her income, spending habits, and lifestyle choices. The basics of this monopoly airline firm are that there are four fare levels. The top four levels of one-way fares are called business fares (not business class) because the complete lack of restriction means they can be rebooked or refunded without penalty and suit corporate activity. The top three levels of leisure fares can be purchased only as return flights, and come at the second level for advance purchase and one regular price level for advance purchase and return flights.

Requirement:

Discuss the monopolist’s price discrimination behavior and respond to the following questions.

Why does the airline firm apply four different fare levels?

What happens to consumer surplus when the monopolist price discriminates?