In pricing and yield management, airlines continually seek to estimate the variable costs of additional passengers. In doing so, United Air Lines (UAL) analysts specified the regression model by regressing the change in total costs each period against changes in revenue passenger miles and system wide takeoffs. The analysts concluded that about 70 percent of UAL’s costs varied with passenger traffic and takeoffs; that is, about 70 percent of UAL’s costs were variable.
This result surprised other analysts, who thought the UAL’s cost must be mostly fixed. These skeptics observed that UAL averages about 35 percent empty seats on its flights. They thought that when UAL carried a few extra passengers, these passengers would sit in the otherwise empty seats. Then, the only incremental costs would be about 25 percent of revenue for extra credit card fees, commissions, fuel, food, check-in agents, and baggage handling. The skeptics assumed UAL would not buy new airplanes and other major assets to handle the incremental passenger traffic.
The analysts at UAL who developed the regression estimates showed that the airline responded to an increase in demand for seats by expanding its total airline capacity, not only by putting the extra passengers in otherwise empty seats.
1. Present a discussion of the differences between variable and fixed cost.
2. As a manager at UAL, how would you use the information in the passage for decision making?
3. Based on your experience or the materials covered in this module, do you agree with their conclusions? Why or why not?4. Significant posts are at least 350 words and require some information from the text, academically reviewed papers, some significant commentary that requires knowledge of the subject matter, a web link to an article or other source in order to be accepted.