Should surge pricing be banned?

Liquid Markets: A lot of sellers and buyers, no transaction cost, easily gauge demand and supply like a stock exchange.

The taxi market was earlier illiquid however it's now liquid. The earlier taxi market was illiquid due to regulations, the cost was pre-defined. But now it's liquid – a market that has an exchange of information & introduction of dynamic pricing.

Traditionally the market in Delhi and Mumbai taxi and autos were regulated by the government by offering limited licenses and thus they restrained the supply and created artificial supply eventually leading to high demand. This further leads to a haggle between the taxi /auto driver and passenger in a state of imperfect information where both the parties do not know the status of demand and supply forces. The passenger will not know if there is another driver around the corner and the driver will not know if he is charging less or more price than the driver next to him.

Uber’s dynamic pricing solves these issues and takes care of the information problem, matching supply and demand pricing problems and changing the situation.

Traditionally, licenses for auto/taxi drivers were issued by the government in pursuance of the regulation of the government i.e. how much the charge will be calculated, how much the drivers can charge, how many hours can a driver work, etc.

And since these licenses are issued by the government and controlled by them there is a demand-supply shortage. This creates a situation for the passengers in the sense that whoever gets to the taxi first will get the taxi, or whoever can pay more will get the taxi. And this is due to a lack of presence of information.

Here Uber provides a mechanism where the information regarding who wants to reach where is transmitted to other users in the form of price. This is called dynamic pricing which offers both parties relevant information.

What this dynamic pricing does is that it incentives efficient drivers to come out into the market. This even acts as a deterrence to people who wanted to use Uber for a trivial purpose and thus offers taxis to people in dire need.

But there were demands to ban dynamic pricing so that the passenger does not pay an absurd amount for these services. This may sound good on the surface as it locks the price and the passengers do not have to pay heavy prices. But in reality, what it does is that it jacks up the average price.

Secondly, it leads to poor resource allocation i.e. people who need these services for an urgent need may not get these services as other people who do not have such urgency may end up using such services. Since dynamic pricing is banned suppliers of such services are not aware of the information as to when their services are needed the most. For example, let's say on a Sunday all the Uber drivers decide to be on a holiday this will lead to extreme shortages. And since there is no dynamic pricing companies cannot incentivize these drivers to come out and offer their services. But if dynamic pricing is allowed then people with urgency can get the available taxis allocated to them and second it incentivizes the drivers to come out on their weekend to earn some extra money.

Third since drivers now know the areas where there is surge pricing they can head over to those places and can solve the demand-supply gap by offering their services in such places.

For a far-fetched idea, it may also create a shift in a lot of people’s careers in the sense if they see that there is more money to be made they may join such services and may further reduce the demand-supply gap.

Another thing that dynamic pricing thus is that it incentivizes the drivers to go out and offer their services in situations of low demand because if that had been a static pricing policy then the drivers would not go out in case of low demand and thus further aggravating the problem of inefficient allocation of resources.

But what about the union leaders who ask to ban surge pricing completely as such services have an upper hand in terms of the price they can charge in times of great demand? For them, I believe removing regulations from the traditional taxi and auto drivers may provide a level playing field as it will help them to think of their own mechanism to charge prices and make the traditional market more liquid instead of making the current industry illiquid by imposing bans on dynamic pricing. Maybe the government can start its own app and follow the same ideas as followed by Uber in terms of pricing.