Can you comment on whether the existence of the loophole does or does not indicate that the airline is charging more than it needs to / why the destruction of the loophole does or does not eliminate some sort of market inefficiency and/or undermine a price gouging strategy?

I've bowed out of the thread as a whole, but since this is a technical question and not a moral one, I'll go ahead and reply. ;-)

First, a bit of background. Under standard cost accounting assumptions, you can say that a seat on an airplane "costs" a certain amount, based on taking the total cost of staffing, maintenance, fuel, etc. Each of these cost allocations is largely arbitrary, however: the truth is that the airline has certain fixed and variable overheads, period, and if the flight is happening at all, the vast majority of those costs have nothing to do with how many people actually travel on the flight. But let's say that we arbitrarily assign costs equally for every seat on the plane, and call that the "fair" price.

(Or, more precisely, the "equal cost allocation" or ECA price, since this "fairness" is just a System 1 intuition that breaks down under closer inspection.)

If airlines asked the ECA price for every seat on every flight, it would be a fairly high amount. This would be more "fair", under some intuitions, but would result in lots of travel not happening at all. People who found the ECA price too high for their intended use, would not buy the ticket. This would result in ECA prices rising, because the airline still has fixed costs for the flight as a whole. When we divide those costs by the (new, lower) number of people actually flying, the cost goes up. Indeed, the airline has to charge an amount that's enough to cover the flight if only a few people show up, or it has to have the option to cancel the flight as underbooked, or it has to offer fewer flights to raise the demand for each flight.

Now we have a market inefficiency:

• There are empty seats on flights that nobody can use
• The few people who travel are paying exorbitant amounts to do so, and
• You can't choose between very many flights.

Under this condition, everybody loses!

Price discrimination solves this problem by decoupling "price" and "cost". The truth is, there is no such thing as how much a seat on a plane "costs": the allocation of fixed overheads and flight overheads is arbitrary and made-up. What really matters is the total revenue brought in by the flight. Our ECA price is a fiction, and discarding that fiction allows us to offer better prices for everybody.

As long is there is some way for the airline to sell at different prices to different people, they can get closer to selling out their flights, by offering the ECA price only on average, rather than by asking everyone to pay it. A business traveler who could afford an ultra-high ECA will actually pay less than under the inefficient-market ECA condition, because the flight is full of vacationers paying smaller amounts to make up for the difference. The vacationers get a lower-than-current ECA price, because there are business travelers making up the difference (though still not paying the inefficient-market ECA price).

This is why the airlines have all the weird fare rules, like roundtrips being cheaper if they cross over a weekend. It's why they want the name of the person traveling, and charge for changes. These are all things designed to separate vacationers from business travelers, so that the plane can be filled and the costs all covered.

The problem is, if business travelers succeed at pretending to be vacationers (e.g. by using half of a pair of round-trip tickets, or wrapping round trips so as to create a fake weekend stayover), then the flight fills up, but at a below-current ECA price. The airline loses money, because they can't make up in volume what they're losing on every seat. That's why they have all sorts of gotchas and enforcement on these loopholes.

Unfortunately, human beings' System 1 intuitions tell them that if somebody is paying $X for a seat, then that must be the "fair" price for any seat on the plane, and that the airline ought to charge everybody that price. So the fare rules are widely despised, even though the result of not having them would be everybody paying a higher price, for fewer seats on fewer flights, if they can fly at all.

Anyway, the specific loophole discussed in this article ("Hidden city ticketing", per Wikipedia) doesn't come from this particular form of price discrimination. It's a different form that basically is done to compete with airlines offering direct flights between two cities, A and B. The airline offering the deal seeks to serve A<->B passengers without adding a direct flight, by using excess capacity that's available on the A<->C and C<->B routes. The airline can offer these seats below the A<->C ECA, because it expects not to fill them with other A<->C or A<->Wherever passengers anyway.

The problem is that if lots of people who were paying something close to the full-flight ECA price for an A<->C ticket, now switch to using hidden city ticketing, they are now losing the airline money on the A<->C flight, because there are more people paying less, instead of some people paying more and others paying less. The airline now has to start raising the direct A<->C price in order to make up the difference, creating more price instability.

tl;dr: Price discrimination is efficient in a market sense, even though it often feels "unfair" to System 1 (because different people are paying different prices for the "same" thing), thereby motivating people to try to work around the discrimination. But successfully working around the discrimination increases the actual unfairness, since the price you get is now discriminated in part by how much extra work you're willing to do to game the system, and because the business is then motivated to make things more discriminatory or is forced to change what offerings it makes available.

(This is what makes loopholes anti-inductive and the use of loopholes a prisoner's dilemma "defection", because you are defecting against your fellow consumers in a game where if everyone defects, everyone loses. That's why talking about such a loophole is so foolish: you are encouraging more people to defect, which reduces the number of co-operators whose cooperation you're exploiting. Even assuming you're going to defect in a PD game like this, telling other people about it is probably the stupidest thing you can do, from a game theory/policy perspective, and that principle applies to a lot more things than airplane tickets.)