Abstract
Demand uncertainty has been recognized as one factor that may cause price dispersion in perfectly competitive markets with costly and perishable capacity. With the persistence of the degree of price dispersion in increasingly competitive markets, demand uncertainty has become more important for us to understand the phenomenon of fare inequality. This dissertation consists of three related studies on this topic. In the first study, Prescott (1975) model is extends by incorporating the heterogeneity of customers' reservation values. The model shows that the equilibrium price dispersion also depends on the mix of customers and their reservation values. With customer segmentation based on reservation values, the equilibrium price dispersion is more efficient than what can be achieved without segmentation. In the airline industry context, the model implies that different prices can exist simultaneously in the market and carriers would provide more seats if they can segment their travelers. This sheds light on an alternative motivation for airlines to require Saturday night stay over other than the practice of price discrimination. In the second study, a price simulation in the airline industry is conducted. The stochastic demand for coach class, nonstop, air travel service on the observed routs is calculated. Then a market price schedule based on Prescott's model is simulated by using nonparametric method. The comparison between the simulated price distribution and the actual price distribution provides evidence that on average more than 60 percent of the fare inequality on the observed routes can be accounted for by cost variation due to demand uncertainty under the condition of perfect competition. At last, an empirical model is specified to explore the relationship between route demand uncertainty and carrier price dispersion in U.S. air travel markets. The results demonstrate that the effect of route demand uncertainty on carrier price dispersion varies with the market structure. In monopoly market, the route demand uncertainty has no effect on carrier price dispersion. While in duopoly and competitive markets, the increase of route demand uncertainty is associated with the decrease of the carrier price dispersion. Furthermore, the negative relationship is magnified when the market becomes more competitive.