Applications of

Binomial Distribution
APPLIED PROBABILITY PRESENTATION REPORT

Akash Chhabria (13174) and Asfandyar Solangi (13065)

 Application of Binomial Distribution:
Introduction:
We consider how overbooking of airline tickets can be modeled using a binomial distribution.
Overbooking is a practice common to hotels, universities, and airlines etc., to make sure the
least amount of rooms, admissions, and seats, respectively, if not none, get wasted. These
establishments expect that if they only offered the same number of rooms, admissions, and
seats, as available, they would end up being wasted due to last-minute cancellations or “no-
shows”. They would then end up in loss, due to not enough revenue being generated to
adequately cover costs. It is rare that more people than can be accommodated show up, but in
that scenario, a “bump-cost” is paid, or delays or deferments of admissions result.
In the economy, efficient utilization of scarce resources is key, and these establishments can
model, using the binomial distribution, the allocation of these resources to optimize revenue
generation. This falls under the field of revenue management, a subsection of operations
management. We carry forward the example of overbooking of airline tickets using an
accompanying dataset.
Before we begin, we make a simple assumption regarding airline tickets.
Assumption:
We assume that airline tickets are booked independently and each passenger’s decision to
show up for the flight or not does not affect the decision of any other passenger. This would
not be completely valid in real-life scenarios, for example in the case of businessmen,
particularly Asian businessmen, who travel together to meetings across the country or abroad.
But, this is rare and, in cases of international flights, can be ignored, hence, allowing us to make
this assumption.
Thus, using past data for the airline, we can find the probability p, which represents the
probability of a passenger showing up for his flight, and 1-p, which, consequently, represents
the probability of a passenger not showing up for his flight. Using n to represent the number of
tickets sold, we can calculate the expected value of the numbers of passengers showing up for
the flight using the formula for the expected value of the binomial distribution that is np.
Dataset:
The dataset accompanying this report helps us evaluate revenue generated and subsequent
overhead costs under different values of overbooked tickets. The number of seats available on
the flight is 200. The price of each ticket is 300. The bump-cost is 500, including the
reimbursement of the ticket price and extra for hotel stay and/or upgrades to business/first-
class. The probability of the passenger showing up for the flight is 0.93, as calculated using past
data. The probability of the passenger not showing up for the flight, consequently, is 0.07. We
measure the expected value of passengers who showed up by multiplying the probability with
the number of tickets actually sold, using our knowledge of the expected value for a binomial
random variable. We also measure the expected value of the difference of revenue and over-
cost using the definition of expectation, as the sum of the product of the value with its
respective probability.
The columns are defined as follows:

 show: the number of passengers showing up

 revenue: product of tickets sold and price of ticket
 over cost: product of bump-cost and the number of passengers who do not get their
seats despite showing up
 rev-cost: the difference of revenue and over cost
 P(show): the binomial probability of “show”
 F(show): the binomial cumulative probability of “show”
 rev-cost*P(show): the product of “rev-cost” and the respective “P(show)”
Application:
Using the data, now obtained, we can experiment using different values of sold tickets, and
observe the changes in revenue and revenue minus over cost to find an optimal level of
overbooked tickets that will allow the airline to maximize efficiency, and minimize losses.
We anticipated that the expected value of show should come close to 200 to achieve this goal.
As observed using the default value, which is 205, the expected value is 190.65, which is still not
close to 200. We experiment by raising the values to 206, 207, and so on, till the expected value
of revenue minus over cost reaches a maximum, and the expected value of show comes closest
to 200 but does not exceed it. We have already tested with large values such as 230 and
observed a trend of revenue minus over cost growing smaller, indicating that overbooking to
such an extent might raise the losses instead of minimizing it. That is why we attempt to make
sure the expected value does not exceed 200. This table summarizes our results:

E(revenue-overcost)
59500
59000
58500
58000
57500
57000
56500
56000
55500
195 200 205 210 215 220 225 230 235
This helps the airline find the optimal level that is 216, to maximize the expected value of
revenue minus over cost, and hence, maximize revenue generated. Coincidentally, the
expected value of show at 216 is 200.88, which is the maximum value that is not above 200, in
the discrete sense.
We notice in this graph, that the expected value of revenue minus over cost begins to fall after
216, due to greater compensatory costs, in the event that more than 200 people show up.
This sort of modelling can thus also be applied to hotels and universities to estimate a value of
overbooking that would be optimal.
Practices such as overbooking has its disadvantages such as loss of face value and customer
trust, but it is easily understood why establishments indulge in it, for instance we can take our
example, of 7% being expected to not show up for their flight, calculated using actual past
experience, we can see why airlines would prefer overbooking. We can also see that the
probability of people showing up as we can increase the number of tickets sold also gets
smaller and smaller.
Hence, in an attempt to maintain a business successfully, it is completely acceptable.
We would like to end by saying this could also have further applications as well, for instance,
using our knowledge of convolution, and with more data, we could have used the same model
for multiple flights. But for descriptive purposes of the applications, we kept our model simple
by limiting it to one flight.