Dear Economist: What’s the point of ‘hidden city’ fares?

I discovered “hidden city” fares some years ago when I learnt that the price of a ticket from JFK to Reykjavik cost much more than a ticket from JFK to London with a stop in Reykjavik. Icelandair explained that they had to compete with many other carriers on the NY-London route. Fine. But I recently bought an Amsterdam-Riga-Helsinki ticket and got off at Riga: the Amsterdam-Riga flight itself was fully twice the price, and competition is not always strong.
I keep buying tickets for seats I do not use on continuing flights that the airline cannot sell to another passenger. I have my theory on why airlines do this – what is yours?
Richard N. Golden

Dear Mr Golden,

Competition is only indirectly relevant. The question is how responsive an airline’s customers are to price – “own-price elasticity of demand”, in the jargon. When elasticity is low, airlines can increase prices without losing many customers. Naturally this affects the price they charge – and one explanation for elastic demand and low prices is that customers could easily shift to another airline.

Customers prefer to fly direct to their destinations, so any indirect route will tend to have to be cheap to attract custom. If competition is weak, the pricing is harder to explain, but demand can still be elastic if people would rather not fly at all than pay handsomely to fly indirectly.

The second question is why airlines charge less for more, as you describe. But from “home edition” software to electronics that have been “chipped” to slow them down, the world is full of discounted products that are more expensive to produce than their full-price counterparts. This raises costs, but if it allows companies to target price increases at those most willing to pay, it makes sense.

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