Game Theory & Airline Pricing
After learning much about game theory in class, I have always wondered how it could apply to real-life situations. I was planning my upcoming breaks with my roommates– getting flight tickets together. We were comparing the flight ticket prices. There are cheaper airline tickets, that don’t allow any carry-on bags; while there are more expensive airline tickets, that allow up to 2 carry-on bags. When we first came to the U.S., we always went for the lowest ticket price. After a few flights, we sometimes find that it wasn’t always the best idea, as we always ended up paying for luggage fees either due to being overweight or oversize. So, this time, we looked up tickets that included baggage in the ticket. Would that be better? This is one of the situations where users make comparisons between airlines.
I came across this article, A game theoretic model for airline revenue management and competitive pricing, the other day, and realized that situation I was experiencing was indeed a great example of game theory. The paper developed a revenue management model. They started by simulating the competitive market between two companies, based on the research they did and the market they observe. Afterward, they applied the formula of game theory and tried to find the nash equilibrium. They were able to find the pure strategy, the nash equilibrium. They found that for larger companies, the prices will gradually decrease to the lowest level and the revenue is comparatively lower compared to monopoly and cooperative markets. This is crucial to airline companies, as we know that many airlines form alliances together. In this sense, the game theory explains to the audience which of the airlines should form alliances together and which of them should not. It is based on the market that they mainly operate in, the flight they offer and the products that they offer along with.
Isler, K., Imhof, H. A game theoretic model for airline revenue management and competitive pricing. J Revenue Pricing Manag 7, 384–396 (2008). https://doi.org/10.1057/rpm.2008.30