You will notice, if there are two identical planes on identical routes, even if one is charging a slightly higher price, it will still get some customers. Also, your LF does not go from 100% to 0% straight away.
I think it is because the game simulates how some passengers will pay for the convenience offered by a flight at the correct time. In other words, if you look at the whole group of potential passengers, some will care very little for the time of their flight, these are the people who will most easily be swayed by a reduced price, then there is a gradual shift all the way to a passenger who is willing to pay a ridiculously higher price for the flight which is at the correct time. Although times are not assigned by you when you set up a route, the game still factors this in. It makes sense, would you get up at 1am to catch a flight to save $5 or would you just pay $5 extra and get a flight exactly when you want it.
This comes to my explanation, a plane holding 20 people can capitalise on this fact. For any one time period, there may be 50 people willing to pay very large amounts of money for a flight, so a 20 person plane can tap into this market. However, a 747, which is very large, cannot charge ridiculously high fares. Admittedly, you will get some passengers (in my example, you may get the 50 people willing to pay a ridiculous amount) but no more. However, if you lower the fares, other people will fly with you.
Summary
The game simulates the fact that some people will pay lots of money for a convenient flight. However, there are not many people like this, and if you have a large aircraft, the only way to fill it is to lower the prices to a level which lots of people will be willing to pay.
Related to this, is the fact that when lots of large aircraft get on a route (thinking on London...), this bonus for small aircraft diminishes in size, because people will be able to get a convenient price on a big aircraft.
