Optimal price–cost margin, service quality, and capacity choice in city-pair airline markets: Theory and empirical tests

This research develops and tests an expected profit-maximising model of pricing, delivery reliability and service frequency under demand risk in city-pair airlines. The theoretical framework reveals an explicit role for the anticipated probability of stockouts in capacity-constrained ex ante pricing decisions. Employing doubly disaggregated data on airline-specific route-specific demand management for 1,855 flights, we test the model and obtain estimates of the simultaneous determinants of demand, price–cost margin, service frequency, and capacity allocated to a route. The results shed new light on the role of capacity controls, schedule frequency, and delivery reliability in rationing by price in a sophisticated revenue management environment.