Impact of Penalty Cost on Booking Decisions

Z. Y. Long

The customer needs to make the booking decision based on her estimation on demand, which is affected by the value of shortage penalty cost. The problem is motivated by lowcost airline service practices where passengers need to book baggage allowance for their travel. The baggage overweight price affects the accuracy of passengers’ baggage weight estimation and thus their booking quantities. Through stochastic decision models, we analytically characterize the impact of shortage penalty cost on passengers’ booking decisions as well as airline’s profit. The results and insights from our study provide guidelines for firms to set their optimal penalty prices.