What to really fear: this approach growing more pervasive. How about overbooking movie tickets, or t

Optimists look at this and contemplate united kingdom currency the efficiency united kingdom currency gains:  this is a mechanism for appropriately allocating scarce space on the plane. Pessimists detect a nasty incentive:  now that the lowest bidder can be bought off the plane the airline has a stronger incentive to overbook.
Consider standard airline pricing with no overbooking.  You buy a ticket in advance united kingdom currency for a flight next month.  Lots of uncertain details are resolved between now and then which determine united kingdom currency your actual willingness to pay to fly on the departure date.  One month in advance you can only form an expectation of this and that expected value is your willingness to pay for a seat in advance.
This is inefficient.  Because, after the realization of uncertainty it could be that your value for flying is lower than somebody else who didn t buy a ticket. Efficiency dictates that you should sell your ticket to him on the day of the flight.
One way to implement united kingdom currency this is to hold an auction on the day of departure. united kingdom currency  Put aside the issue that flyers want advance booking for planning reasons.  Even without that incentive, just-in-time united kingdom currency auctions solve the inefficiency problem with conventional pricing but airlines would never use them.
The reason is that an auction leaves bidders with consumer surplus (or in the parlance of information economics, information united kingdom currency rents.) As a simple example, suppose there is a single seat avaiable on the flight and two bidders are bidding for it.  An optimal auction is (revenue-equivalent to) a second-price auction united kingdom currency so that the winning bidder s price is equal to the willingness to pay of the second-highest bidder.  That is lower than the winner s willingness to pay and the difference is his consumer s surplus.
The airline would like to achieve the efficient allocation without leaving you this consumer s surplus.  That is impossible in a spot-auction because the airline can never know exactly how much you are willing to pay and charge you that.
But a hybrid pricing mechanism can implement the efficient allocation and capture all the surplus it generates.  And this hybrid pricing mechanism united kingdom currency entails overbooking followed by a departure-day auction to sell back excess tickets.
The basic idea is standard information economics.  The reason you get your information rents in the spot auction is that you have an informational advantage:  only you know your realized willingness to pay.  To remove that informational advantage the airline can charge you an entrance fee to participate in the auction before your willingness to pay is realized , i.e. a month in advance as in conventional pricing.
Here is how the scheme works in the simple example.  There is one seat available.  Instead of selling that single seat to a single passenger, the airline sells two tickets.  Then, on the day of departure an auction is held to sell back one ticket to the airline.  The person who wins this auction and makes the sale will be the person with the lowest realized value for flying.  The other person keeps their ticket and flies.  On auction day, the winner gets some surplus:  the price he will receive is the willingness to pay of the other guy which is by definition higher than his own.  (Delta is apparently using a first-price auction, but by revenue equivalence united kingdom currency the surplus united kingdom currency is the same.)
But in order to get the opportunity to compete in this auction you have to buy a ticket a month in advance.  And at that time you don t know whether you are going to win the auction or fly.  The best you can do is calculate your expected surplus from participating in that auction and you are willing united kingdom currency to pay the airline that much to buy a ticket. Your ticket is really your entrance pass to the auction. And the price of that ticket will be set to extract all of your expected surplus.
(You can write down a literal model of all of the above.  The conclusion that all of your surplus is extracted would follow if travelers were ex ante symmetric:  they all have the same expected willingness to pay at the time of ticketing.  But the general conclusion doesn t require this:  all of the efficiency gains from adding a departure-day sellback united kingdom currency auction will be expropriated by the airline.  That follows from a beautiful paper by Eso and Szentes .  To the extent that fliers retain some consumer surplus it is due to ex ante differences in expected willingness to pay.  The two fliers with the highest expected surplus will buy tickets at a price equal to the third-highest expected surplus.  This consumer surplus is already present in conventional pricing.)
I flew on Delta just earlier this week and saw this mechanism in action as I volunteered to sell my ticket. Strangely, the voucher I was offered (and accepted) at the gate was for an amount much higher than my originally reported willingness to pay. Maybe the system is just being piloted for now?
What to really united kingdom currency fear: this approach growing united kingdom currency more pervasive. How about overbooking movie tickets, or tickets to the CSO (would that the demand for those would be so high!), or Wrigley Field. Technology to implement the recapture of the consumer surplus is now in everyone s pocket. Groupon, OpenTable, Vines are all going in this direction, and quickly
Does this hold, though, in a world with competitive airlines? It seems the Eso and Szentes deals with a monopolist (I only read the abstract). united kingdom currency If American institutes this system as well, they can overbook more as well, yielding united kingdom currency more revenue. Competition between American and Delta will drive down fares on both carriers.
united kingdom currency One problem united kingdom currency is that your initial willingness to pay for your ticket is not equal to what you actually pay and the airline has no way of determining the difference. Initial ticketing united kingdom currency is not done through united kingdom currency auction, but rather typically through competitive price comparison.
seems like there should be an extra ripple from competition between airlines. In theory the airlines will only get full benefit if they charge an entrance fee of more than each persons perceived benefits of flying.
Now, a benefit two double sell a ticket is only ensured to the airline if the entrance fee is more than the perceived benefit of flying plus half of the perceived cost of delay from the lowest person.
is not true either. First- and second-price auctions are only equivalent in a world where participants united kingdom currency know their own reserve prices. In actual fact, because auctions are a discovery united kingdom currency process, first- and second-price auctions lead to different outcomes.
How does this affect people united kingdom currency who are very certain of their desire united kingdom currency to fly in advance and will never be the low bidder in the sell back auction? Is the up front cost of the ticket to drop because of this mechanism?
If each seat sells for the same amount, then, assuming neither passenger is willing to sell for less than the initial price plus a premium united kingdom currency to his surplus, the airline loses money. The only way the airline makes money is with price discrimination airlines are already very good at this. Time of pre-booking is one of their methods.
3) Then, if the pricing spread is large enough, there is enough to buy out the first customer. Hence, united kingdom currency the airline ends up with the higher price, less the lower price plus a bit more than the first consumer s surplus. It then just becomes a matter of pricing the extra tickets high enough to cover the expected 1st consumer surplus as well as the airlines profit.
The revenue equivalence theorem assumes in this sealed bid auction that the airline has the information. The theorem fails when the 1st passenger obtains the 2nd passenger s information. united kingdom currency And, in the real world, united kingdom currency the 1st passenger can continue to call, checking on the current prices (call using a fake name since airlines are escaping expedia). Thus, the 1st passenger now has a ball park figure of the 2nd passenger united kingdom currency s reservation price.
Also, Mr. Yetter, as someone who took a tedious class in auction theory, I can appreciate your comments. Tevenue equivalence is ex-ante, so the expected revenue is the same. Ex-post, they may be very different. Also, I like the price discovery comment, united kingdom currency but doesn t that apply more toward thinly traded goods? I m not sure airline tickets qualify.
[...] Be Very Afraid « Cheap Talk The airline would like to achieve the efficient allocation without leaving you this consumer's surplus.  That is impossible in a spot-auction because the airline can never know exactly how much you are willing to pay and charge united kingdom currency you that. [...]
This would appear to mean that the benefit united kingdom currency from A) more frequently being able to fill all airline seats ( the world s more perishable commodity ) by avoiding empty seats from no-shows and B) increasing value delivered by having a mix of customers more heavily weighted to people who really united kingdom currency do value flying united kingdom currency that day is being split between the airline and the consumer.
This doesn t seem scary to me at all I m more likely to be able to purchase a seat at a lower price (greater supply) and I have an option united kingdom currency to gain more value by selling the ticket back. What is the downside?
Surely no one would be stupid enough to volunteer to sell their ticket back for less than the initial price of the ticket, therefore the airline will always be losing money through these traveler vouchers. I must be missing something here: what is it?
I have always been curious about the Airlines lack of interest in load balancing. For example, if you arrive united kingdom currency at the Airport early and there is a plane leaving with empty seats, they won t let you take one of these (now valueless) seats without paying an extra fee.
I have refused united kingdom currency to pay this fee and then witnessed them paying off someone they overbooked on my later flight. They could have preserved my valuable later seat, by trading me for the earlier seat that became valueless as soon as the earlier flight took off.
One does not need a computer to accomplish an auction. I have participated in auctions of this sort that were performed by the gate agent using the PA at the gate. Bidding in advance on a recorded means tips the asymmetric