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A price for everything

15 October 2014 By Edward Hadas

Surge pricing is what car service Uber calls its reliance on the market mechanism. The use of price to balance supply and demand is a perfect example of standard economic theory in action. It is also a good example of why market economics can have an anti-social edge.

Uber finds the market-clearing price with an algorithm rather than the auction found in textbooks. But the principle is the same. As the fare goes higher, more drivers decide to stay on the road and fewer would-be passengers decide to use the service. While Uber’s calculation is biased to maximise rides rather than driver revenues – it will choose 10 fares of $10 over one fare of $100 – the balancing price can be as much as seven times normal.

The surge approach is not new, but it has become more common in recent years. Hotels and airlines charge low prices off-season and very high prices during holidays or conventions. Restaurants, utilities and shipping lines try to guide customers with discounts and surcharges. For such enterprises, which have high fixed costs and face quite sharp changes in the natural level of demand, it makes sense to encourage customers to use their facilities when they would not naturally want to.

Still, considering how often the economy is described as a market system, Uber-style variability is surprisingly rare. Both prices for consumers and wages for workers are usually more or less steady through the course of the day and over the seasons. In percentage terms, the deviations created by money-off offers and higher rates for working overtime are generally pretty modest.

Prices may become more variable as data mining becomes more sophisticated, but price consistency has a lot going for it. To start, it is often more efficient. In most types of business, uneven prices just lead to undesirably uneven demand, requiring expensive boosts and cuts in production. Everything is likely to go more smoothly when prices are related directly to costs, which do not change much. The price-shifters are in a different position, but they are the exception, not the rule.

The widespread use of steady cost-based pricing also promotes economic stability, because it helps support steady wages, which promotes sustained demand. If short-term market pressure is allowed too much sway, employers will tend to respond to competition by cutting prices and then pay. The variability and uncertainty is likely to restrain consumption.

Then there is the social question. The extremes of the market can undermine the common good. Uber, under pressure from the New York Attorney General, has admitted as much. It agreed to limit the use of open market price calculations during emergencies and natural disasters. It did so to comply with a law against price-gouging. The law is based on the principle that prices should be just.

The just price idea was developed in the Middle Ages but is still sound. A price that is far above the costs of production brings unfair gains to the seller. The fact that some transactions take place at highly profitable prices does not change the ethical argument. It only means that some consumers are gullible or desperate. Conversely, prices that are too low are unjust to the workers who actually make the product or provide the service. They deserve a fair reward for their labour.

Of course, if the market-clearing price is not used to allocate scarce goods and services – from taxi rides on New Year’s Eve to the finest university education – some other method will be required. There are several.

For taxis, regulation can help reduce the scarcity. The right to collect fares can be matched with the obligation to provide a service at undesired hours. But if there is still too little supply, the traditional technique of forcing passengers to wait puts the poor on a more even footing with the rich, which seems fitting for a public service. What the affluent do in private is their own affair, but any company that wants to sell to everyone has a universal responsibility.

Elite education used to be allocated largely on the basis of price, and only the rich could afford it. That may still be partly true in practice, but in theory selection is nowadays primarily based on merit. In medical care, the rich also used to have priority, but in most developed economies basic care, at least, is now supposed to be provided largely on the basis of need. Merit and need are hard to determine, but they are more just criteria for allocation of vital goods than wealth.

Uber’s surge pricing is not necessarily evil, but it is not unarguably right just because it shows the market in action. The question of whether money should buy privileges – from political influence to a taxi at closing time – is inevitably ethical. It is too important to be left to economists and algorithms.

 

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