Reference no: EM133023498

In 1981, American Airlines introduced the AAirpass. For $250,000, a customer could buy unlimited first-class travel on the airline for life. For an additional $150,000, she could bring a companion on any flight she took. Now, that is a lot of money. I fly a lot, but it would take a long time before I spent a quarter of a million dollars on airfare. But to the Ryan Binghams of the world, it isn't that hard to run through a few hundred thousand dollars of tickets. So, while most of us didn't buy an AAirpass, people like Ryan Bingham did, and saved a substantial amount of money doing so.

Bob Crandall, who was American's CEO for much of the life of the AAirpass, admitted, "We thought originally it would be something that firms would buy for top employees. It soon became apparent that the public was smarter than we were." Some AAirpass holders have been known to fly so much in one month that buying the tickets would have cost $125,000. Having learned its lesson the hard way, American steadily raised the price of AAirpass to over $1 million before canceling it altogether. After that, American has been investigating some AAirpass holders in hopes that it can show the customers acted fraudulently, thus giving the airline an excuse to cancel its obligation.

1. (a) Where is the information asymmetry in this case?
2. (b) How does the information asymmetry lead to a market failure?
3. (c) Propose possible solutions to restore market efficiency.