Third-degree Price Discrimination in the Presence of Congestion Externality

This paper analyzes third-degree price discrimination of a monopoly airline in the presence of congestion externality when all markets are served. The model features the business-passenger and leisure-passenger markets where business passengers exhibit a higher time valuation, and a less price-elastic demand, than leisure passengers. Our main result is the identification of the time-valuation effect of price discrimination, which can work in the opposite direction as the well-known output effect on welfare. This time-valuation effect clearly explains why discriminating prices can improve welfare even when this is associated with a reduction in aggregate output.