Monday, June 7, 2010

Auctions for Overbooking

Wall Street Journal article "Auctions for Overbooking" (June 6th, 2010) suggests (wisely) that airlines have auctions for bumped seats--that if they overbook a flight by five people, they offer increasing amounts of money to someone who gives up their seat until five people have given up their seat.
The airlines also benefit because an auction may save them money over a set price or a government penalty. More importantly, United, American and the rest are assured that fewer passengers are unhappy at the end of the process. That's no small matter given the reputation for poor service that most airlines have with the public.
More than this, airlines are guaranteed to save money by selling bumps to the lowest bidders. In particular, if an auction is held to elicit five passengers to give up their seats, certainly the passengers who face the lowest cost for getting bumped will be the ones to accept the airline's offer first. This means that the airline will pay (at best) a total amount equal to the sum of the five lowest values of flying. However, if people instead know before they purchase a ticket for a flight that on average, some people are forcibly bumped, then they will shave the amount that they are willing to pay for a ticket by the probability that they are bumped times the cost of getting bumped. This means that the price of tickets falls from the marginal value to the marginal value minus the probability of getting bumped times the marginal cost of getting bumped. In general, this marginal cost will exceed the lowest costs of the passengers and so the airline will receive less total revenue when it randomly bumps passengers than when it holds an auction to buy back overbooked seats.


  1. This is the most upbeat corrections post yet. A good reminder that journalists miss on both sides; sometimes writing things that are untrue, and other times omitting information that would benefit the reader. Good post.

  2. If you are right, it may be no coincidence that Corrections is"upbeat" with respect to a Wall Street Journal article.

    The Wall Street Journal opinion editorial page is an economist's dream. It regularly has opinions by respected economists, such as Gary Becker or Kevin Murphy, or features quotes by George Stigler, an academic whose ideas have been a foremost influence on this blog, or a Milton Friedman. The Journal by and far has the most erudite commentary provided by any major newspaper.

    For an example of this sort of penetrating thinking, see today's Wall Street Journal editorial: "Feel the Rage" (June 9th, 2010):

  3. The comment re the WSJ editorial page is quite right. It is an almost unique place for facts and logic well expressed and considered. Probably not a coincidence that it occurs in perhaps the only major paper that did not contract the sickness of advocacy journalism.