in this video we're going to take a look at how Airlines build their Fair structures and specifically why we find so many fairs for the same airline in a given market and to do that we're going to examine a demand curve for a c sample market so let's choose a sample Market let's say we want to look at the demand for JFK JFK Miami and let's let's assume we know what the demand curve looks like for JFK Miami so let me draw a demand curve over here uh we're going to draw my vertical axis and
then my horizontal axis I think they could be a little bit bigger I want to give myself enough room to draw here so let me draw that a little bit a little bit bigger vertical axis and vertical axis and horizontal axis that's good line those up nice and then let me add in a downward sloping demand curve downward sloping demand curve and put a little bit of a Bend to it that didn't work out so let me try that again downward sloping demand curve little bit of a Bend to it good um having a little
bit of trouble with that downward sloping downward sloping okay good and then um here let me just move that out a bit now actually one more time give me one more chance to draw a nice demand curve oh I'm lucking that one okay just move that out just a little bit good good and then let's label our axes P for price on the vertical axes axis excuse me P for price and on the horizontal axis we have q for quantity okay good let me go ahead and copy and paste that so we can use it
twice crop crop copy okay copy and paste good now we have two demand curves we can work with okay let's start out by assuming that the airline only has one price in this market so they have one price for all seats from JFK to Miami and recall that revenue is the product of price and quantity so let me write that down here just to remind you Revenue equals Revenue equals price times quantity okay so you know for any for any product let's say you have uh widgets and you're selling your widgets for $10 a piece
and you sell five widgets then your revenue from those widgets is going to be $50 in our case it's seats instead of widgets but that's how you calculate Revenue so if the airline only had one price in the market they would choose the price that maximized Revenue so let's say they determined that that price is represented by P1 so they choose the price that maximizes revenue and let's call that P1 and at P1 they sell q1 seats q1 seats so the revenue that they will capture by pricing their product at P1 will be P1 *
q1 okay the total revenue from pricing their product at P1 is P1 * q1 and if you recall revenue is represented by this area under the curve so if we shade this in this area here this rectangle is is is the the amount P P1 * q1 this rectangle is you know the the uh area of a rectangle is the um one side times the other this side is a length of q1 this side is a length of P1 so P1 * q1 equals the total revenue from this price and indeed under this demand curve
all of this area represents Revenue but choosing this price will only capture this amount of Revenue so that's fine an airline or any firm would want to price their product in such a way that they maximize Revenue so they choose the point along the demand curve that maximizes Revenue so let's say this point is uh representing uh X customer customers so X customers at this point on the demand curve uh will be willing to pay P1 for this many seats well let's take a look at what's happening on the rest of the demand curve then
down here below P1 on this portion of the curve down here down here there are customers who are willing to fly from JFK to Miami but they're not willing to pay P1 let's say there are some customers uh y who are at this point in the curve let's use a different color here uh at this point of the curve are willing to pay some price P2 and you're willing to purchase Q2 seats so at this price the airline could sell more seats to the Y customers but at a lower price up here above above the
demand for P1 there are customers who are willing to pay higher than P1 so let's choose a point here let's call those Z customers who are willing to pay P3 albeit there are fewer of them fewer receipts would be sold at that fair but there are customers who are willing to pay above P1 and pay P3 for Q3 seats and remember the demand curve is the representation of willingness to pay by consumers in the market so so now the airline looking at this demand curve will see that there are a couple of opportunities that are
have gone by here right if they're pricing their product at P1 there are customers along the demand curve who are not willing to pay P1 they're willing to pay something less but they're not willing to pay P1 and because the price is above their willingness to pay they won't travel so this Revenue this area under the demand curve is going to be a lost opportunity up here there are customers who are willing to pay P3 but since there's only one price in the market P1 those customers will travel but they will pay a lower fair
that they're than they're willing to pay so this we call consumer surplus so the consumers are benefiting in this area of the curve because they're willing to pay more than the airline is charging so the airline might look at this and say wow we could we could sell more seats if we lower our fair or we could actually charge a higher fair and get lower quantity but if you were to if you were to look let's see if we can uh shade over this uh let's see what color I'll use here orange if my price
was P3 and I only sold Q3 quantity then my Revenue would be P3 * Q3 and it may be hard to see this here but this area of this re rectangle P3 * Q3 is a smaller area than P1 * q1 so they could raise the fair but they would actually lower Revenue similarly at P2 they could lower the fair sell more seats and capture this area but this area too is smaller than the original area of P1 and q1 so lowering the fair would also reduce Revenue so they have their optimal fair at P1
and it doesn't make sense for them to move off of that fair to either raise it or lower it because that would reduce Revenue but they are concerned that they are are they're missing out on this consumer surplus and they're not getting anything here um for seats that could could have been sold at a lower fair so let's go over to our other demand curve here and let's write in let's write in those prices and quantities again so we had P3 up here P1 and P2 and let's see if we draw some vertical lines maybe
that's not very vertical but I think you get the idea uh Q3 at this price Q2 at this price and q1 at this price so now if the airline instead of having one price and considering whether to increase or decrease that price they kept that original price the q1 price and then added in two different fairs now they would be able to capture customers who are willing to pay P3 would purchase Q3 C seats so they would get this revenue from that fair then the customers who are willing to pay P1 would buy Q2 seats
and they'd get this additional revenue from this overlapping rectangle and then customers who wouldn't fly at all under the old structure would now be able to travel at P2 and the airline would also capture this Revenue so with more fairs in the market they're able to capture more Revenue under the curve now they are still missing out some opportunity up here in this portion of the demand curve there are customers who are willing to pay P3 excuse me greater than P3 they'll get the seats for P3 over here their customer willing to pay more than
P1 but they're only going to pay P1 similarly these customers would be willing to pay more than P2 but they'll get it for P2 and down here there's there's no fair in the market to satisfy this demand so these customers won't travel because there's no fair uh that they be be willing to pay pay so the more fairs in the market the more area that they're able to capture and of course you could C you could carry this to a extreme degree you could have 20 fairs in the market 30 fairs in the market of
course that would become too cumbersome there's already enough fairs in the markets um so the airline will try to choose the number of fairs that they can manage that the consumers will understand and that competitively will be sustainable in the market so that they can capture as much of the revenue opportunity that exists under this curve
