Micro Economics

An Analysis of the article

India's Price Ceiling On Uber

Rides Hurts Riders, Drivers And
The Economy – Forbes

Submitted to: Submitted by:

Nidhi Chand Ma’am Oshin Sharma
 Index

1. Introduction
2. How does Uber work?
3. Why build a price surge model?
4. Uber’s Price Surge Model: Explained
5. Uber Surge: Benefits vs Harms
6. Government’s Intervention in Uber’s Pricing Model

a. Government as a welfare state

b. Price Ceiling
c. Ways of Imposition
d. Impact on riders, drivers, and the economy

7. Prospective Solutions: An Opinion

8. Conclusion
9. Footnote
10. Appendix: Original article
INTRODUCTION

Uber is an American technology company that operates the Uber car transportation and food delivery mobile app by
acting as a marketplace for drivers that act as independent agents and consumers. It provides a variety of
transportation options to consumers based on different price levels and luxury services. Its famous price surge model,
which works on an algorithm (whose details Uber keeps confidential) multiplies the price of rides when the demand
rises, has recently garnered concerns over increasing price levels to an extent deemed unfair towards the buyers by
many governments and has hence been met with the imposition of Price Ceilings by various countries including India.
This paper aims to analyse the economic forces working inside Uber’s pricing model and the impact the price ceiling
by India has caused on drives, riders, and the Indian economy.

HOW DOES UBER WORK?

Although it is a company offering a service to consumers, Uber differs from other market players in that it cannot
entirely control the supply of the service it aims to provide, that is transportation, because the drivers that work for
Uber are independent contractors having the right to choose the time during which they want to work and when they
do not want to work. Unlike hotel or flight companies, Uber works not only to maintain the demand of its service, but
also the supply. It has to ensure that when consumers demand more rides, drivers actually supply them.

WHY BUILD A PRICE SURGE MODEL?

In Boston, during late nights on weekends, Uber noticed a spike in “unfulfilled requests.” While the consumers were
looking for rides, the drivers were switching off the system to go home. The supply could not meet the rising demand
on weekends. The Boston team experimented by increasing the fare provided to drivers on weekends, and noticed
about an 80% increase in supply, fulfilling two- thirds of the requests. Precisely, the supply curve for Uber cars was
highly elastic; meaning that for any given change in price, quantity supplied showed a noticeable change. Another
research proved that Uber’s demand curve is highly elastic too; meaning that at lower prices, quantity demanded by
the consumers will increase.

Uber’s highly elastic Demand

and Supply curve.
(approximation)

This is the ideal situation wherein

buyers are willing and able to pay
the price for a ride to the
suppliers who are willing and
able to supply the ride at the
given price P1.

Here, the demand and supply

intersect at point E1, the
equilibrium, at which the market
functions at Price P1 and
Quantity Q1.
UBER’S PRICE SURGE POLICY (DYNAMIC PRICING POLICY)

The model comes into play when demand of Uber rides exceeds the supply provided by drivers and when the supply
of Uber rides exceeds the demand.

When demand outstrips supply, there arises a need to hike prices to reach equilibrium.

When Demand outstrips supply,

meaning when there is a rightward
shift in the demand curve, it moves
from D1D1 to D2D2 at the prevailing
price P1. In this case, the quantity
demanded Q1 exceeds the quantity
supplied Q* by (Q*-Q1) leading to a
shortage.

A shortage implies that Uber’s

unfulfilled rate would skyrocket, and
most customers would be left
without a ride.

This incites a need for an increase in

quantity supplied and/or a decrease
in quantity demanded.

As soon as prices are increased, market gains equilibrium.

When prices are raised from P1 to

P2, quantity demanded moves from
E* to E2 (Quantity demand falls)
and quantity supplied moves from
E1 to E2 (Quantity supplied rises)
thereby reaching market
equilibrium at point E2 with an
equilibrium price of P2 and an
equilibrium quantity of Q2.

This price rise from a given P1 to

P2 is done by Uber’s price surge
algorithm which stabilizes market
outcome by reducing demand and
increasing supply temporarily.

However, since these situations are always temporary, eventually supply outstrips demand.
When supply outstrips demand, there arises a need to reduce prices to reach equilibrium.

When supply outstrips demand, meaning

when there is a rightward shift in the
supply curve, it moves from S1S1 to S2S2
at the prevailing price P2. In this case, the
quantity supplied Q3 exceeds the quantity
demanded Q2 by (Q3-Q2) leading to
excess supply.

An excess supply implies that drivers are

waiting for riders, who are unwilling to
demand rides at the given price P2.

This incites a need for an increase in

quantity demanded.

As soon as prices are decreased, market gains equilibrium.

When prices are reduced from P2

to P1, quantity demanded moves
from E2 to E3 (Quantity demand
rises) and quantity supplied moves
from E* to E3 (Quantity supplied
rises) thereby reaching market
equilibrium at point E3 with an
equilibrium price of P1 and an
equilibrium quantity of Q3.

This price fall brings the prices

back to equilibrium, proving that
the price hike is temporary in
nature and that prices have the
power to affect market
equilibrium.
UBER PRICE SURGE: BENEFITS VS HARMS

Benefits
Surge got more drivers on the road during times they’d rather stay
home.That meant more rides, and short wait times.
Surge provided on time and efficient rides to buyers who valued the
allocated resouce by agreeing to pay higher for it.

Harms
Markets became unfair to buyers and were
charging more and more amount from
buyers at a time when they were in most
need of the given service.
Consumer welfare was being harmed.
GOVERNMENT INTERVEMTION IN UBER’S PRICING MODEL

The Government as a welfare state is obliged to protect the rights of consumers and prevent consumer exploitation due
to various factors, price being a major one of them.

In India, Uber’s price surge was deemed unfair by the state and hence the Delhi high court, in its verdict, granted
permission to all states where Uber operates to set a maximum limit on Uber’s price surge.

Price Ceiling is a legal maximum imposed on the price at which a good or service can be sold. It aims to protect the
interests of the buyers in a market.

UBER’S PRICE CEILING CAN BE IMPOSED IN TWO WAYS:

I. PRICE CEILING IS BELOW THE EQUILIBRIUM PRICE

Price ceiling PC has been

imposed by the government at a
point lower than the equilibrium.

In this case, the market cannot

function outside the light blue
shaded area i.e. the market has to
function below the price ceiling
imposed by the government.

At the price ceiling Pc, quantity

demanded Q3 exceeds quantity
supplied Q2 resulting in a
shortage.

It implies that at lesser prices,

drivers may not be willing to
supply rides to potential buyers
thereby reducing supply.

IMPACT OF PRICE CEILING

ON RIDERS:

1. Riders can now ride at lower prices during peak times.

2. Not all riders who demand rides will get them, because price ceiling set by the government may cause a
significant decrease in supply.
3. Longer waiting periods, as supply is limited.

ON DRIVERS

1. Lower income and low profit margin of the same service

2. Lower incentive to work

ON THE ECONOMY

1. Market size may shrink as buyers due to their inability to find rides at the desired time may switch to other
modes of transportation and drivers may not be willing to supply the service.
2. Drivers may switch their jobs, moving into a lay off period.
 II. PRICE CEILING HAS BEEN IMPOSED BY THE GOVERNMENT ABOVE THE EQUILIBIRUM
PRICE

Price ceiling PC has been

imposed by the government
above the equilibrium.

In this case, the market can

function in the shaded area.

It implies that even though

the government has set a
price ceiling, it will not
affect market outcome
because from points Q3 and
Q2 which reflect excess
supply, the market can
freely move back to the
equilibrium point E1 as it
comes inside the area of
market functioning despite
government intervention.

IMPACT OF PRICE CEILING

This type of price ceiling does not pose any significant impact of the market because it allows the marker forces to
freely move towards the equilibrium price and quantity.
This type of price ceiling prevents the market from rising the price too high i.e. above the price ceiling level in cases
of excess demand or supply.

PROSPECTIVE SOLUTIONS: AN OPINION

Price controls are established with the aim of maximizing societal welfare. However, it is observed that maximum
prices imposed by ceilings lead to a shortage and consumers had to either wait for long hours to get an Uber ride or
did not get any ride at all. If instead of imposing price ceiling, the government lets the market for Uber function freely,
the outcome may be better in terms of balanced demand and supply due to the following reasons:

a. Without price controls, when there will be an increase in supply at peak times, price will automatically
shift towards the new equilibrium and that price rise will ensure that supply will be uninterrupted as
drivers will be incentivized to work for longer periods of time;
b. Consumers who value Uber rides more than other alternatives will be ready to pay a higher price to obtain
the ride and hence during peak times rides will be allocated to those who value it most;
c. Consumers who do not find the high price worth the ride will switch to other modes of transportation –
something which was also happening, when the government imposed a price ceiling on Uber rides, to
those consumers who did not want to wait for long hours to find a ride and those who could not find any
ride at all;
d. Letting the markets function freely will prevent shrinkage in the size of the market as both consumers and
suppliers will be satisfied; for those consumers who would find Uber’s price surge high would always
have the option to choose from other alternatives in the market.
CONCLUSION

Uber’s price model gave the perfect ground for forces of market – demand and supply – to work. The company aimed
at ensuring both maintained a balance so that both riders and drivers were at a benefit. It was observed that prices
played a key role in bringing the economy back to equilibrium at which both suppliers and consumers are satisfied.
However, when government interfered in the market functioning, it caused a disruption (shortage) in one case where
price ceiling was below equilibrium price, whereas in the other case where price ceiling was above equilibrium price,
it did not. Given the severe impact of price ceiling highlighted in the above sections, it was observed that the impact of
the price ceiling hurts drivers, riders, and the economy. And hence, all in all, the market, if allowed to function freely
will make the consumer as well as the suppliers in the marker of Uber better off than when price controls are imposed.

MAIN ARTICLE

Forbes - https://www.forbes.com/sites/jonhartley/2016/05/31/indias-price-ceiling-on-uber-rides-hurts-riders-
drivers-and-the-economy/#4c71727b2e0e

BIBLIOGRAPHY

1. https://newsroom.uber.com/guest-post-a-deeper-look-at-ubers-dynamic-pricing-model/

2. http://economictimes.indiatimes.com/news/economy/finance/uber-passes-service-tax-burden-on-to-cab-
drivers-agrees-to-give-info-on-driver-members-to-taxmen/articleshow/44808062.cms

3. http://www.business-standard.com/article/companies/india-s-transport-ministry-allows-surge-pricing-on-
premium-ola-uber-rides-116121600936_1.html

4. http://www.govtech.com/applications/Ubers-Surge-Pricing-4-Reasons-Why-Everyone-Hates-It.html

5. http://viewfromthewing.boardingarea.com/2017/05/21/ubers-new-pricing-model-may-charge-make-wish-
return-surge/

6. http://faculty.chicagobooth.edu/chris.nosko/research/effects_of_uber's_surge_pricing.pdf

7. https://medium.com/the-wtf-economy/improving-uber-s-surge-pricing-3fd2fe108bd6

8. https://hbr.org/2015/12/everyone-hates-ubers-surge-pricing-heres-how-to-fix-it

FOOTNOTE

The opinions stated in the document are the author’s personal beliefs which have been built up in the
course of research. The paper mainly focuses on establishing a better economical understanding of
the basic concepts used in Uber’s operations and functioning, the impact of the functioning on
countries from the point of view of a welfare state, and analyses the impact of the step take by India
– price ceiling – with the aim to increase welfare of the consumers without causing damage to the
economy. It also implicitly compares a price ceiling market for Uber with the same market without
any price controls and analyses the impact of both situations on the stakeholders in a condensed
format.

The first points on the index provide a background essential towards understanding the analysis of
the main article whose interpretation starts from point 6 on the index.
APPENDIX
Original Article
India's Price Ceiling on Uber Rides Hurts Riders, Drivers and The
Economy – Forbes, May 31, 2016.
Recent regulatory blowback against Uber, Lyft and other ridesharing services around the world have
reignited the ongoing regulatory policy debate surrounding the ride service in India, Uber’s second
biggest market in terms of cities where it operates. Most prominently, India’s government recently enacted
legislation that allows major cities to arbitrarily set limits how much ride service companies such as
Uber can charge riders during peak times.

As surge pricing often results in fares above the new price ceilings set by the Indian government resulting in
supply-demand problems, a potential shortage of rides problem now arises during times of peak demand.
Meanwhile, opponents against surge pricing in India argue that the fare price ceiling helps to maintain
competitive fares for current cab drivers.

Price ceilings on Uber fares will create shortages of available drivers, longer wait times and
deadweight loss

If India really cared for its drivers and riders, it would remove the price ceiling for surge pricing during peak
times in order for the supply-demand of rides to reach what economists call an equilibrium. There
are examplesthroughout history that when a government sets these sort of price controls on goods, it
interferes with the natural supply and demand equilibrium price and amount of those goods, creating
shortages and surpluses. For example, long lines formed at gas stations during the 1970s when the U.S.
government put a price ceiling on gasoline, stopping the price from going high enough to reach the
equilibrium market clearing price between consumers and producers, creating a shortage. Consumers were
incentivized to consume more of the good than they would have consumed under normal market conditions
and producers were incentivized to produce less of the good because they couldn’t sell at a price high
enough to recoup costs and make profits.

India’s current price ceiling and the predictable shortages for rides during peak times is bad for both the
riders, drivers, society, and leads to a deadweight loss because of the misallocation of time, money, human
capital and human potential.

New academic research highlights how surge pricing is necessary to prevent shortages of Uber rides

A new paper by researchers at the University of Chicago Booth School of Business the economics of Uber’s
surge pricing demonstrates that in the absence of surge pricing at peak times wait times for rides increased
from the average of less than three minutes for those willing to pay the surge pricing, to over fifteen minutes
across the board.

The paper illustraates Uber’s surge pricing mechanism behind incentivizing more drivers to come out during
peak times, and what happens when this mechanism fails, in order to have a constant and ready supply of
drivers for riders willing to pay. Uber incentivizes its drivers with a price high enough for them to
outnumber ride requests most of the time. This helps to make sure the supply of drivers is ready for riders at
any given time and keeps the riders happy. The Booth School paper also talked about how because of the
surge price outage, the price of a ride couldn’t go high enough to signal to Uber drivers to come out, thus
resulting in longer wait times.